Buy Ten Peaks Coffee for gains and income

We’ve replaced Sun-Rype Products with Ten Peaks Coffee on The Back Page. We think that Ten Peaks earned more last year and it’s expected to earn more in 2014, It pays highly attractive dividends. Buy Ten Peaks if you can accept buying a stock we rate ‘Speculative’.

We advised you to tender Sun-Rype Products when we last examined beverage stocks on The Back Page. Since we published our September 13, 2013 issue, Great Pacific Industries has taken Kelowna, B.C.-based Sun Rype private. If you owned Sun-Rype, you will have received $7.50 a share.

We’re replacing Sun-Rype with Ten Peaks Coffee Co. Its main business is the Swiss Water Decaffeinated Coffee. This premium chemical-free green coffee decaffeinator is based in Burnaby, B.C. It supplies retailers of coffee. Ten Peaks also owns and operates Seaforth Supply Chain Solutions. This is a green coffee handling and storage business in Metro Vancouver. It won organic certification last February.

Rising earnings support high dividends

Ten Peaks is thought to have earned more money last year and is expected to earn even more in 2014. It has paid a dividend of 25 cents a share in each of the last three years. We expect the company to pay 25 cents a share in 2014. Based on the share price, the dividend yields an attractive 6.7 per cent. The shares also have a positive technical outlook. As a result, we rate Ten Peaks a buy for long-term gains and high income. But only if you can accept buying a company that we rate ‘Speculative’.

In the nine months to September 30, 2013, Ten Peaks earned $1.311 million, or 20 cents a share. This was up by nearly 43 per cent from $914,000 or 14 cents a share, a year earlier. Sales fell less than costs. That’s thanks to higher process and distribution revenues that moderated the fall in sales.

In the first nine months, Ten Peaks’ sales sagged by 15.4 per cent, to $38.1 million. But that’s because the price of coffee futures has fallen after hitting historic highs in 2011. Coffee futures averaged $1.31 a pound. That’s down by 28 per cent from $1.82 a pound, a year earlier. The company writes that its “green coffee cost recovery revenue (the base amount it charges customers for green coffee) also fell.” Ten Peaks uses coffee futures contracts to manage fluctuations in coffee prices.

Ten Peaks’s cost of sales fell by a higher 19.2 per cent, to $33.8 million. All other costs jumped by 31 per cent, but came to only $2.6 million. As a result, pre-tax income rose by nearly 41 per cent, to $1.665 million. The income tax also jumped by 31 per cent, to $354,00. But the income tax rate fell by 1.5 percentage points, to nearly 21.3 per cent.

President and chief executive officer Frank Dennis says, “Our efforts to win new business and gain market share are paying off in higher volumes…and our financial results have improved across the board.” At the same time, the extent of the earnings improvement is not confirmed by the statement of cash flows.

In the first nine months, Ten Peaks’s cash flow rose by 16.2 per cent, to $3.704 million. While this is up respectably, it’s up far less than the jump in profit. On the positive side, the company made good use of the cash flow. It invested $272,000 in plant and equipment and paid dividends of $1.251 million.

Ten Peaks Coffee carries little debt

Ten Peaks used the excess cash flow and excess working capital to repay debt of $2.62 million. As a result, its net debt-to-cash-flow ratio is a comfortably low 0.6 times (debt of $4.525 million less cash of $1.926 million divided by the cash flow of $4.226 million over the last four quarters).

Excess cash flow and the strong balance sheet give Ten Peaks the means to continue investing in the growth of the business. Seaforth, the green coffee handling and storage subsidiary, has required investment to grow quickly. Its organic certification makes it “well positioned to further increase its business.” In the third quarter, a competitor of Seaforth disappeared. Demand for Seaforth’s services was so brisk that it opened a second warehouse and added more staff in August. In September, it bought a site next to the second warehouse. This raised Seaforth’s storage capacity by 175 per cent.

Seaforth should contribute more in 2014

Ten Peaks writes, “The rapid growth caused Seaforth to incur some one-time expansion costs, which reduced its contribution to Ten Peaks’s year-to-date results. However, Seaforth is expected o make a modest contribution to the company’s financial results in the final quarter of this year.” It should contribute more to the earnings through 2014.

Ten Peaks’s main business is also increasing. Its sales to national accounts are gradually recovering as the price of coffee returns to more traditional levels. Even so, it writes that “specialty regional business has recorded strong and steady growth over the past three years. These smaller, quality-focused customers are a natural fit…as they appreciate the company’s commitment to producing excellent quality, chemical free decaffeinated coffees.” There’s room for further growth in this segment.

In the first nine months, Ten Peaks generated sales of $21.1 million in Canada. That’s 55.5 per cent of its total sales. Sales to the U.S. came to $14.2 million. That was a significant 37.3 per cent of total sales. The company generated sales of $2.8 million elsewhere. This amounts to 7.2 per cent of total sales. Ten Peaks uses foreign exchange forward contracts to cut its foreign exchange exposure. This will offset the benefit of the recent fall in the loonie. But at least Ten Peaks can operate with greater certainty.

We see the coffee culture expanding in North America. Coffee-shop chains include Tim Hortons, Starbucks, Timothy’s World Coffees, Second Cup, Van Houtte, Dunkin Donuts, Coffee Time and others. Even McDonald’s now offers ‘gourmet’ coffees to raise its breakfast sales. The industry still has a lot of independents as well. The thing is, there is only so much caffeine that people can safely consume. As a result, we believe that Ten Peaks’s decaffeinated coffees will gain ground—particularly with insomniacs.

We think that Ten Peaks earned about 27 cents a share in 2013. That’s up from earnings of 23 cents a share, the year before. This year, the company is expected to earn 34 cents a share. Based on this estimate, the shares trade at a reasonable forward price-to-earnings ratio of 11.0 times.

Buy TEN PEAKS COFFEE COMPANY INC. $3.75 (Quality rating: Speculative; Sector: Consumer; TSX—TPK; T: 604-444-8780; www.tenpeakscoffee.ca)  for long-term gains and high dividends. But only if you can accept buying a stock we rate ‘Speculative’.

 

The Investment Reporter, MPL Communications Inc.
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