Green Mountain - The Best Buy In Coffee

By Bill Edson - September 7, 2012 | Tickers: CBOU, DNKN, GMCR, PEET, SBUX | 0 Comments

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Euro zone stress and higher prices for robusta coffee beans may negatively impact coffee companies with significant global footprints. These and other forces are percolating to create a bitter environment for many coffee companies. Investors should be very selective when picking between these stocks.

Many Coffee Stocks Sell Luxury

Many publicly-traded coffee stocks are highly sensitive to economic downturns. These companies mark up an affordable commodity to designer prices. Dunkin' Brands Group (NASDAQ: DNKN), Starbucks (NASDAQ: SBUX), Caribou Coffee (NASDAQ: CBOU), Peet's Coffee & Tea (NASDAQ: PEET), and Green Mountain Coffee Roasters (NASDAQ: GMCR) repackage or prepare coffee drinks at price points between $1 and $6 per cup when a person can brew coffee from expensive beans at the cost of roughly $1.00 per pot. Individuals who indulge in these luxury coffee products will often cut back on them in times of economic distress. For this reason, these companies should be regarded as highly cyclical.

European Coffee Demand Cools

At present, cafés in Europe are struggling to turn a profit as the weak European economy has reduced disposable income of many European households. Although cafés are an important social venue in European culture, tighter budgets limit the amount of money that can be spared for buying coffee at a café. Although many coffee drinkers are switching to more economical coffee options rather than completely cutting it out of their diet, if the economy does not pick up, many coffee venues may be forced to close.

Many Europeans have dealt with the economic stress of unemployment, higher taxes, and reductions in pay have also caused Europeans to choose cheaper, lower-quality coffees. Gourmet arabica coffee was much preferred in Europe up until Europe’s economic crisis. Now, Europeans are switching to robusta, a bitterer but less costly alternative. This trend, which has been the norm for over two years, has turned the global coffee market on its head as Europe has the greatest coffee consumption rate per person. Whereas in the past arabica was the more coveted coffee, over the past year arabica prices fell by 30% while those of robusta rose by 18%. The price difference between these two types of coffee has reached a low since July 2009. It is expected to narrow further as Vietnam’s production of robusta beans has been revised lower.

Europe accounts for about one half of coffee imports, and economic weakness translates into reduced imports. In Spain coffee imports fell by 6.6% while Italy imported 2.9% less for the six month period ending in April.

Grinding Individual Coffee Stocks

The effects of European economic weakness will be felt differently by different coffee stocks depending on their footprint.

Peet's Coffee & Tea will not be directly impacted by foreign economic headwinds because its operations are focused in the United States. Green Mountain Coffee Roasters is similarly focused in the United States, which accounts for 85% of its revenues. Most of Green Mountain’s remaining revenues, 14.5%, come from Canada.

Other coffee stocks are much more exposed to global shocks. Starbucks derives 25% of its store revenues from outside the United States and 37% of its locations reside outside of the United States. Caribou Coffee is in a similar situation, with 27% of its shops located outside the United States. Dunkin’ Brands has an intermediate exposure, with roughly 30% of its locations located outside of North America.

Dunkin’ Brands faces domestic challenges as well. Three owners of failed Dunkin’ Donuts branches are suing Dunkin’ for racial discrimination. Two African Americans and an Indian-American claim that their business decisions were negatively influenced by the franchise. Amy and Reggie Pretto, two African Americans, maintain that Dunkin’ all but forced them to open stores away from the New York/New Jersey area. Instead they built their branches in an area in Maryland where there was less business. The plaintiffs claim that their businesses failed because of less desirable Maryland locations. Priti Shetty, an Indian-American, claims that she was harassed by Dunkin’ Donut’s operation managers because of her gender and was stopped from opening a third store in Stockholm, New Jersey. Dunkin’ Brands shares to dropped since these suits have been filed.

With these factors in mind, it appears that Dunkin’ Brands faces the most risk, followed by Starbucks and Caribou Coffee, while Green Mountain Coffee Roasters and Peet's Coffee & Tea bear the least risk.

Valuation

Valuation multiples for these coffee stocks vary considerably:

Green Mountain Coffee Roasters is the cheapest stock on this list based on a low price-to-book multiple and a low price-to-earnings multiple. It is also expected to experience the greatest earnings growth according to analyst estimates. Hence, it is a better value and a better growth stock than other stocks on this list. It is also insulated from global economic issues. For these reasons, it is the best stock pick among these coffee companies.

Though Peet's Coffee & Tea is similarly insulated from foreign economic weakness, its valuation multiples make it unattractive. With a price-to-earnings ratio of 68.19, it is very expensive.

Caribou Coffee and Starbucks are trading at high multiples. Investors should demand lower valuations to take on the risk of cyclical stocks whose products are cut from budget-minded consumers.

Dunkin’ Brands is inexplicably priced. It trades at higher price-to-earnings and price-to-sales multiples than Starbucks or Caribou Coffee even though it faces similar global challenges, firm-specific legal issues. Worse yet, analysts forecast lower growth for Dunkin’ Brands. For these reasons, Dunkin’ Brands may be an attractive short candidate for portfolio hedging.

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