For Peet's Sake (PEET, SBUX)

Starbucks SBUX appears bitterly determined to end its failing distribution relationship with Kraft Foods KFT; perhaps they've been drinking too much of their own dark roast? Yesterday, the specialty coffee giant said that it wants to end its 12-year distribution deal because of breech of contract and it is willing to go to court to do it. Starbucks contends that Kraft management frequently shut it out of sales meetings and used knowledge gained from their relationship to launch its own coffee brand. SBUX also alleges that KFT damaged its image to consumers. Starbucks' management said that they wanted to “go it alone” as soon as possible, but what does that really mean. There are a number of outcomes to the issue, which in and of itself is not a cheap fix (SBUX may end up paying $1 billion to end to relationship). The company could simply develop their own grocery store sales and distribution network, which would take quite a bit of time, but ultimately result in an operation that works more in-line with how the company wishes. Starbucks could also look to the market for a quick fix, where it could purchase Peet's Coffee & Tea, Inc. PEET. This $507 million market-cap specialty coffee roaster, marketer, and retailer of whole beans already has a vast grocery store distribution network—beans are available at nearly every major chain around (check their retail store locator). While Peet's coffee does have some ancillary businesses that go along with the distribution, such as home delivery and 192 retail stores, these could be easily folded into the much larger Starbucks umbrella or sold off altogether. So, what do the numbers say? Peet's Coffee is trading just off of a 52-week high, which was set back in August. It has been tested frequently since then and shares appear ready to break out either way. PEET trades at 30x this year's earnings and 24.7x next year's earnings. Its growth rate is decently high compared to peers, at 16.80%, but that doesn't completely justify the lofty multiple—its PEG ratio is currently 1.47. With that said, PEET's earnings and free cash flow have been positive for the past three and five years, respectively, and PEET's growth rate is expected to bump higher over the next few years, toward 19.80% according to Wall Street estimates. Adjusted for the higher growth rate, the PEG ratio would be closer to 1.25, a much more compelling number. So, could Starbucks buy them? Sure. Would the transaction be a steal? Not at all. Though would they be drastically overpaying for the company, especially given that they are in a time of need? No. Cheers.