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Author: pencils2 Big gold star, 5000 posts Top Favorite Fools Feste Award Nominee! Old School Fool CAPS All Star SN Explorer 1 Mission Team Member Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 2753  
Subject: Peet's Coffee and Tea Date: 3/1/2006 11:59 PM
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Peet's Coffee and Tea

~Starbucks founder is on the board of directors
~Growing consistently and increasing revenue
~Strong balance sheet for a small-cap

Company

A Dutch immigrant, Alfred Peet, started Peet's Coffee and Tea. Peet arrived in San Francisco in the 1950's and opened the first Peet's in 1966. The store did very well; many people would line up just to get a fresh cup of coffee. A second Peet's opened in 1971. Inspired by Peet's, Jerry Baldwin went to Seattle and started Starbucks. Alfred Peet sold Peet's in 1979 to a coffee machine importer, Sal Bonavita. Two more stores were built in a span of four years after that, then surprise, surprise! Jerry Baldwin bought Peet's Coffee and Tea in 1984. Because of increasing duties at both Peet's and Starbucks, Baldwin sold Starbucks in 1987, and is still on Peet's board of directors today. Peet's only had four stores once Baldwin took over. Baldwin had resisted aggressive expansion at Starbucks, but he realized Peet's days as a small company should end. He let new blood come in to start expanding Peet's. Soon 5-6 Peet's were being built a year, and the wholesale business was picking up business as well. Peet's IPO was in 2001 when they wanted to really become a gourmet coffee supplier and reach new customers.

Business

Peet's Coffee and Tea is a marketer of fresh coffee beans and a specialty coffee roaster. Freshness is all Peet's. Peet's has strict freshness rules for their coffee and tea, something that giant Starbucks doesn't quite have (They have some less strict freshness standards as far as I know). Peet's offers fresh tea leaves, another thing that isn't too common in the U.S. these days. Peet's also offers fresh pastries in their retail shops.

Peet's also does the wholesale business, you will see their coffee and tea in many grocery stores. Peet's grocery accounts have gone from 130 to 3500 in the last three years!

Peet's has one roasting facility, but they are planning to build a new facility this year to meet their total demands. Now, you may be wondering, why are there so few Peet's retail shops? First, Baldwin was not very heavy on expansion. He opened one store per year, which is why he stepped aside as CEO and let a more aggressive team come in to expand the business. Second, Peet's has only recently boosted their wholesale business to a great number, now they are making much more revenue from that business. I think that management did a good job being patient, building up the cash, and now they are doing heavier expanding.

At year-end, Peet's had 92 retail shops, 20 built last year. For fiscal 2006, Peet's hopes to build 23-28 new shops and that roasting facility. Look at this graph to see Peet's sales, retail makes nearly twice as much as specialty sales (Grocery outlets is the main specialty).

Construction on the new roasting facility (It will be in Alameda, California) is scheduled to start this April and finish in December. Once it is finished, the estimated cost will be around $24 million.
                                   13 weeks   14 weeks   52 weeks    53 weeks
January 1, January 2, January 1, January 2,
2006 2005 2006 2005


Retail stores $33,453 $30,381 $118,030 $100,444
Specialty sales 17,180 14,689 57,168 45,239
Net revenue 50,633 45,070 175,198 145,683

Operating expenses:
Cost of sales and related
occupancy expenses 23,806 20,834 80,374 67,189
Operating expenses 16,329 14,270 59,060 48,530
Marketing and advertising
expenses 1,333 1,162 4,008 3,775
Depreciation and amortization
expenses 1,934 1,628 7,299 5,794
General and administrative
expenses 2,325 2,538 8,757 7,262

Total operating costs and
expenses 45,727 40,432 159,498 132,550

Income from operations 4,906 4,638 15,700 13,133

Interest income, net 593 267 1,769 922

Income before income taxes 5,499 4,905 17,469 14,055

Income tax provision 2,059 1,713 6,782 5,270

Net income $3,440 $3,192 $10,687 $8,785

Net income per share:
Basic $0.25 $0.24 $0.77 $0.66
Diluted $0.24 $0.23 $0.74 $0.63

Financials

Peets currently has a market cap of 420.67 million. Peet's has a very nice $53.08M in cash with no debt, a current profit margin of 6.1% and operating margin of 8.96% (Trailing Twelve Months). These charts show the situation.
                                                     
January 1, January 2,
2006 2005

ASSETS

Current assets
Cash and cash equivalents $16,996 $11,356
Short-term marketable securities 36,080 --
Accounts receivable, net 5,152 4,136
Inventories 16,148 12,614
Deferred income taxes 1,514 1,403
Prepaid expenses and other 3,372 2,280
Total current assets 79,262 31,789

Long-term marketable securities 16,890 52,057
Property and equipment, net 46,313 40,588
Intangible and other assets, net 5,434 3,455

Total assets $147,899 $127,889

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities
Accounts payable $5,523 $5,710
Accrued compensation and benefits 5,563 4,266
Deferred revenue 3,415 2,394
Other accrued liabilities 3,030 3,372
Total current liabilities 17,531 15,742

Deferred income taxes 1,759 838
Deferred lease credits and other long-term
liabilities 2,537 2,182
Total liabilities 21,827 18,762

Shareholders' equity
Common stock, no par value; authorized 50,000,000
shares; issued and outstanding: 13,902,000 and
13,500,000 shares 99,273 93,091
Accumulated other comprehensive loss, net of tax (76) (152)
Retained earnings 26,875 16,188

Total shareholders' equity 126,072 109,127

Total liabilities and shareholders' equity $147,899 $127,889

Peet's ended 2005 with cash and cash equivalents of $70M, compared to $64.3M at year-end 2004. What I really like here is this: Peet's is doing the heaviest expansion of its history. This is the most aggressive they have been ever! But they are still increasing revenues, improving sales, and they aren't racking up too much debt. I have never seen a small-cap company do this so well (Although I'm sure you have!), if they can continue to do what they have been doing, I believe this could be an opportunity at our feet.

Management

Patrick O'Dea, CEO, age 43

Patrick has served on Peet's board of directors since May, 2002, I have been impressed with his management of the company and I hope he will be CEO for many more years. Prior to working at Peet's, he was CEO of Archway/Mother's Cookies and Mother's Cake & Cookie Company for 4 years. He has had various other jobs at Stella Foods and Procter & Gamble.

Thomas Cawley, CFO, age 44

Thomas has been Peet's CFO since July, 2003. Prior to working at Peet's, he was CFO at Gap Brands, had various jobs at Yum! Brands, PepsiCo, Pizza Hut, The Quaker Oats Company, and General Foods.

James Grimes, Vice President of Operations, age 49

James has served at Peet's since July, 2002. Prior to this, James worked with Archway/Mother's Cookies, Mother's Cake and Cookie Company, Frito Lay, and Procter and Gamble. In 2001 he founded Supply Chain Consulting.

Peter Mehrberg, Vice President, age 46

Peter has been Vice President of Peet's since 1997. He has worked in some different roles with the company. Mehrberg served as Director of Real Estate from 1994 to 1997. Before joining Peet's, he worked in law and real estate.

Bruce Schroder, Vice President, age 45

Bruce has been VP since 2003, he is also the General Retail Manager and has worked with various parts of Peet's. Bruce was also CEO for HomeGain.com, worked at PepsiCo for 16 years, The North American Coffee Partnership, and SoBe.

To learn about Peet's roasters, take a look at this:

http://www.peets.com/who_we_are/people_leaders.asp

Expansion

Right now, Peet's has 92 stores in the U.S, but not all are in California. Peet's has one shop in Denver, 8 in Seattle, 5 in Portland, 6 in Boston, and 2 in Chicago. This leaves a total of 70 shops in California.

As far as expanding, Peet's is focused on the western part of the U.S. I estimate that they will focus on the west for 2-3 years, then they might start pushing east. But don't count on seeing a Peet's in the east (Aside from what they already have) for at least 2 years.

Insider Holding

Insiders only own 3.57% of all shares outstanding; institutions own 67.8%. So this isn't a very “Hidden” small-cap as you'd find in Hidden Gems. I really like the growth opportunity at hand, I would rather have that institutions number lower, but I think Peet's offers a great opportunity with or without heavy institutional ownership.

This is the one part that worries me with Peet's. In the last six months, insiders have sold more than 160,000 shares. Institutions have sold more than 200,000 shares! I don't really look at this with too much concern, why? Because insiders have stock portfolios also, they want to diversify their holdings. If any more heavy selling does happen, I will definitely be concerned and will look into the matter, but for now, insider selling won't affect me with opening a position.

Competition

I think anyone could write this paragraph! Of course, Starbucks is the first name that pops into people's head when thinking of Peet's competition. Let me tell you this: Peet's offers different products than Starbucks; people go to Peet's for a different experience than Starbucks. What I'm trying to say is that Peet's products are different from what Starbucks offers. Peet's has fresher products, tea, rare coffees etc. Peet's offers more exotic and rare products than Starbucks. It may be hard to imagine where Peet's will build their shops, since there are so many Starbucks around. Peet's was faced with this problem in years past and revenue keeps increasing, I feel that Peet's management will be able to find the right locations to succeed. Nevertheless, we have to keep a close look on Starbucks, just to see what their market strategy at this time is. I think Starbucks will build some more locations in the U.S. before focusing on China, that's my guess, but I'll be keeping a close look on events between Starbucks and Peet's.

Kraft Foods, Green Mountain Coffee, Procter and Gamble all have products that will be competing with Peet's in the grocery stores, but Peet's is increasing revenue in that area as well. Basically, as long as Peet's is increasing revenue and expanding, I feel comfortable with the competition. If sales take a sudden halt, I will be worried. I don't think competition will hurt Peet's, because Peet's has unique products with great quality that is, in many cases, hard to find in another product.

Risk

I see a couple risks involved with Starbucks. The first is if Peet's cannot find effective areas to build new shops and make a profit. Peet's will have to be careful with choosing new locations, they have done a great job so far and I think they will continue to do so. Second, if Starbucks chooses to stay in the U.S. and try to really compete with Peet's, that could hurt the company. I don't think Starbucks will do anything like this, but it is important to stay on top of Starbucks strategy's.

Peet's does not hold any patents for their roasting methods, so a company could try to duplicate Peet's roasting process. If this does happen, Peet's will still be a very unique company. I believe their sales would be just as strong. Competitors could also find a better roasting strategy than Peet's, which could hurt sales. I think it all comes down to believing in Peet's. I doubt any of this could be prepared for, at least to my knowledge, so it all comes down to what you believe Peet's will be able to do.

The specialty coffee market is a very competitive one, but Peet's product is unique enough to keep the company's sales in good shape. I just think that it's hard to match Peet's freshness, quality, and unique products with anything else.

Outlook

For fiscal 2006, Peet's hopes to open 23-28 new retail shops, targeting total net revenue growth or 20-23%. Revenue growth will be key with the new facility being built and the new retail shops. I am hoping that Peet's can have a good amount of cash with no debt, but with the heavy expanding this might be hard to do. Peet's also issued a slight warning with earnings:

Peet's is targeting earnings per diluted share of $0.80 to $0.83 for fiscal 2006, excluding the impact from the expensing of stock based- compensation; the impact of expensing stock based compensation in 2006 is expected to lower earnings per share by $0.18 to $0.20;

Their cash position should be fine if everything goes as planned:

Capital expenditures are expected to be in the range of $18 million in fiscal 2006, excluding the purchase of the new roasting facility.

Conclusion

I am going to be opening a position in PEET very soon; I think a great opportunity is at hand.

For additional research, I encourage you to look at these:

Web Site: http://www.peets.com/

Discussion Board:
http://boards.fool.com/Messages.asp?bid=114833

Coffee Menu:
http://www.peets.com/stores/espresso_menu.asp

Tea Menu:
http://www.peets.com/stores/tea_menu.asp

Complete Store List:
http://www.peets.com/stores/store_list.asp

Comments, questions, and other feedback is appreciated.

Foolishly,

pencils2

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