Caribou Coffee Trading at Short-Term Discount to Peers

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Caribou Coffee, Inc.

A weak tape, illiquidity, and (presumably) a seller playing for a takeout have created a unique opportunity to own a strong regional QSR operator with 10%+ unit growth, FY13 commodity tailwinds, and recent top-line momentum at a steep discount to its peers and its own historical valuation.

Caribou Coffee (CBOU), a ~$215mm market cap gourmet coffeehouse operator, is off ~13% since reporting solid 3Q12 earnings and as much as 7% yesterday in the absence of any fundamental company-specific news. The only reasonable explanation I can think of for yesterday's sell-off is that someone owned CBOU as a takeout candidate for SBUX and is dumping the position after SBUX announced their acquisition of Teavana (TEA). This has left CBOU trading at just 5.4x FY13 EBITDA. I recommend buying CBOU here with a target price of $14.50 (~8.0x EBITDA, ~37% upside from current levels).

Thesis:
(1) Resilient top-line: The retail segment’s recent 3Q12 results were impressively resilient during a period of broader restaurant weakness. Their 2-yr SSS trend actually accelerated 20bps in the quarter (from +7.5% to +7.7%) while most other QSR operators saw fairly significant deceleration in the quarter.

(2) Coffee price tailwind: Coffee prices have come in significantly this year, which will provide a significant COGS tailwind in FY13 while other restaurant operators are expected to struggle with another year of +3-4% food cost inflation. Arabica coffee prices have declined 35%+ in 2012 and continue to fall.

(3) K-Cup drama overhyped: CBOU got caught up in the ‘K-Cup bubble’ this past year, which has created an unreasonably large overhang on the stock.

(4) Valuation is cheap: I value CBOU on an EV/EBITDA basis in order to account for their net cash position. CBOU currently trades at 5.4x consensus FY13 EBITDA of $33.8mm. This is well below the QSR average of 9.3x and significantly below the coffee QSR average of 10.9x (DNKN 13.1x, SBUX 10.9x, KKD 10.4x, THI 9.3x). There are plenty of legitimate reasons why CBOU should trade at a discount to the other coffee QSR operators: added risk because of geographic concentration, unproven ability to successfully expand units outside of their core footprint, and of course the most topical reason, uncertainty/volatility in their Commercial segment. Acknowledging that the future of the Commercial segment is largely a wildcard, I look at valuation excluding the segment. I project FY13 EBITDA ex-Commercial to be $24.6mm. Ultimately, you’re paying 7.5x for a retail coffeehouse business that is 33% franchised, expects 10-12% unit growth next year, and has top-line momentum in a weak environment. This is still a significant discount to its coffee QSR peers (to account for the aforementioned reasons), plus you get a free option on the Commercial segment.

My target price of $14.50 represents a conservative 8.0x FY13 EBITDA -- a discount to QSR and other coffee names and around the valuation that CBOU was trading at prior to the K-Cup bubble. If the Commercial segment outperforms expectations, strong SSS trends continue, and new unit productivity is strong in FY13, I see no reason why this shouldn't trade in-line with QSR (9.3x EBITDA or a target price of $17.00, 61% upside). I expect this valuation to be realized as results in the Commercial segment stabilize and the market comes to appreciate the Retail segment's defensive SSS momentum and coffee cost tailwind.

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