3 Reasons to Sell Coffee Holding

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Even a great business can find itself in trouble when things go sour for its clients. Imagine being the guy who sold light bulbs to Enron. Coffee Holding (NAS: JVA) is a good little business, but one big client has made it change the way it operates, and that is not going to end well.

Coffee Holding made 56% of its 2011 sales to Green Mountain Coffee Roasters (NAS: GMCR) , which helps explain the shift that Coffee Holding had from roast coffee to green coffee last year. It also creates issues that the company could continue to suffer from if it continues to focus too intently on green coffee.

Green Mountain's share of Coffee Holding Company's business has been growing in recent years, which has been good for revenue in the short term. Unfortunately, it looks like a bad decision for the long haul. Green Mountain has recklessly grown inventory levels, which results in inflated, unsustainable demand for coffee from Coffee Holding. When inventory aligns, those sales to Green Mountain are likely to come crashing down.


Instead, Coffee Holding should be looking at its competitors for guidance. Smuckers (NYS: SJM) is one of the larger competitors that Coffee Holdings fights with for shelf space. Smuckers' Folgers coffee is a nationally known brand and has served the company well. Instead of supplying other companies with raw material, Smuckers generated a 24% profit margin last year on $2.3 billion in coffee sales. Coffee Holdings has to see the value of selling roasted coffee because of its higher margins.

Coffee Holding's own inventory
In 2011, inventory jumped up 28% compared to 2010 (with a 43% increase in coffee prices accounted for). While inventory growth would be excellent if sales continued to grow, any slowdown will result in write-offs. Coffee Holding estimated that for every 1% increase in write-offs, operating income takes a $135,000 hit.

With operating income at negative $500,000 last quarter, even a small shift in inventory could result in a seismic hit to the bottom line. If Green Mountain were to pull back, Coffee Holding would be left out to dry. Compound that with the complete lack of a long-term agreement with Green Mountain, and it's clear that inventory management is paramount. Last year's growth is a bad sign.

Net income is dropping
Because of the shift from higher-margin, roasted coffee to green coffee, sales costs have increased, and income has dropped. Net income fell from $1.2 million in Q2 2011 to a $370,247 loss in 2012.

Coffee Holding is in direct competition with industry leader Starbucks (NAS: SBUX) , which increased revenue by 9% last year. Its net income grew 32% to $1.2 billion. It sells its own branded coffee that competes with Coffee Holding's roasted coffee. It's the No. 1 name in coffee, in the U.S. and internationally. That's bad news for Coffee Holding.

The bottom line
Until Coffee Holding can break free of the grip that Green Mountain has on it, it's going to be in trouble. The shift in product mix away from roasted coffee is hurting its margins, and the focus on a single customer is going to kill it in the very near term. I expect the company to have a bad 2012. Hopefully, it will learn its lesson and go on to be the good little roaster that it has been for the past 80 years, but until I see changes, I'd stay far away.

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At the time this article was published Fool contributorAndrew Marderdoes not own any of the stocks mentioned in this article. The Motley Fool owns shares of Green Mountain Coffee Roasters and Starbucks.Motley Fool newsletter serviceshave recommended buying shares of Green Mountain Coffee Roasters and Starbucks.Motley Fool newsletter serviceshave also recommended creating a lurking gator position in Green Mountain Coffee Roasters and writing covered calls on Starbucks. The Motley Fool has adisclosure policyWe Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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