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Peet's Remains at Neutral

Zacks Equity Research

We have maintained our Neutral rating on Peet’s Coffee & Tea, Inc. (:PEET) with a target price of $67.00 following first quarter 2012 results.

Peet’s delivered operating earnings of 25 cents per share in the first quarter of 2012, which missed both the Zacks Consensus Estimate and the prior-year earnings of 31 cents and 41 cents per share, respectively. The first quarter results plunged owing to high input costs, especially for coffee.

We are encouraged by Peet’s strategy to sell premium-quality and premium-priced product in its specialty coffee segment. Besides the Peet's brand, which is already the quality and price leader in the dark-roast segment, the company  introduced the Godiva chocolatier brand coffees in 2009 in order to enter the medium-roast segment. Moreover, in July, Peet’s introduced its new Light Freddo line of blended iced coffee beverages, which have up to 50% fewer calories than their regular Freddo counterparts. In August, the company entered the largest product segment of the specialty coffee category in grocery stores with the debut of two new medium-roast coffees in ground and whole bean form: Peet's Café Solano and Peet's Café Domingo.

Sales climbed 7% in the reported quarter, on the back of strong fundamentals, robust business growth and strong sales growth through its various distribution channels. The company has improved its top-line since the past three years with a year-over -year increase of 7.2%, 9.3% and 14.2% in 2009, 2010 and 2011, respectively.

The company also expects continued revenue growth in 2012 from further expansion of the grocery and foodservice businesses and existing retail stores. In retail, the company expects to open new stores in strategic west coast locations, and in grocery, the company expects to continue to expand into new markets like western U.S., eastern seaboard and other selected markets. In addition, Peet’s will expand its presence in the foodservice and office environment too. All these efforts bode well for the company’s top line growth in the long term.

However, rising coffee costs have negatively impacted the profitability of the company since many years. Coffee prices have increased significantly since 2005, and in 2011, coffee costs were 42% higher per pound than in 2010. Further, green coffee costs have also been rising since 2008.The company expects the coffee prices to increase further with the growth of the specialty coffee industry.

Moreover, the specialty coffee category is highly competitive and fragmented among various distribution channels. Starbucks Corporation (SBUX) is the largest competitor in category. The company is also facing stiff competition from the emerging coffee makers, who intend to brew a single cup at a time. The United States single cup market is currently dominated by Green Mountain Coffee Roasters (GMCR) with its cartridge-based Keurig K-Cup brewing system. Starbucks is the exclusive, licensed super-premium coffee brand produced by Green Mountain for the Keurig Single-Cup brewing system. Presently, Peet’s is lagging behind and requires to enter an agreement with the owner of the brewing system to have Peet’s-branded coffee and tea available in cartridges that work in the brewers.

Though Peet’s offers premium quality coffee backed by superior price position in the market, the higher cost inflation and difficult macro-economic environment keep us on the sidelines with a Neutral rating.

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