Bitter Blends: Which Coffee Roasters Can Make You Money This Quarter?

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

A bitter blend of high valuations, macroeconomic headwinds, and bad press has made coffee stocks largely unpalatable for investors. Most of these stocks are not recommendable, and investors should wait for the market to brew up a fresh pot of sweeter valuations and richer fundamentals.

Bad Press

Starbucks (NASDAQ: SBUX) faces flak for its indecent labor laws and ill-treatment of workers in Chile. The Supreme Court of Chile has fined the coffee giant $50,000 for threatening layoffs, withdrawing benefits, and replacing workers while they were strike. The strike at Starbucks happened last year in order to protest for increasing lunch stipends and pay hikes to keep up with inflation.

Starbucks’ U.S. worker relations are considered among the best in the restaurant business. The company has been able to pass through some of its growing sales to U.S. baristas and other staff, avoiding cause for unionization altogether. Different units inside the company and affiliates have different worker relations. In its defense, Starbucks spokesman Jim Olson remarked, “We have always recognized and respected our partners' right to affiliate with a union and to voice their opinions."  However, Olson also commented “While we disagree with this latest ruling we respect the court's decision”

The labor practices of local Starbucks units spurred the Chile’s Labor Department to ban the coffee company from placing a bid to supply to local offices of the government.

Dunkin’ Brands (NASDAQ: DNKN) faces bad press for domestic problems. 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.

European Coffee Demand Cools

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

Many Europeans face economic stress: unemployment, higher taxes, and pay cuts. Now many Europeans are choosing cheaper, lower-quality coffees. Gourmet Arabica coffee was preferred in Europe until Europe’s economic crisis. Now, Europeans are switching to Robusta, a bitterer but less costly alternative. Since Europe has the greatest coffee consumption per person this trend has global consequences. The past market premium for Arabica beans has narrowed over the past year because of a 30% drop in Arabica and a price increase in Robusta 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.

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

Peet's Coffee & Tea (NASDAQ: PEET) will not be directly impacted by foreign economic headwinds because its operations are focused in the United States. Green Mountain Coffee Roasters (NASDAQ: GMCR) 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 (NASDAQ: CBOU) 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.

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, Starbucks, Caribou Coffee, Peet's Coffee & Tea, and Green Mountain Coffee Roasters repackage or prepare coffee drinks at price points between $1.00 and $6.00 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 stocks should be regarded as highly cyclical.

Euro zone stress and higher prices for Robusta coffee beans may negatively impact coffee stocks 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.

Grinding Individual Coffee Valuations

Valuation multiples for these coffee stocks vary considerably:

<table> <tbody> <tr> <td> <p><strong>Ticker</strong></p> </td> <td> <p><strong>Company</strong></p> </td> <td> <p><strong>P/E</strong></p> </td> <td> <p><strong>P/S</strong></p> </td> <td> <p><strong>P/B</strong></p> </td> <td> <p><strong>EPS Growth Next 5 Years</strong></p> </td> </tr> <tr> <td> <p>CBOU</p> </td> <td> <p>Caribou Coffee Company</p> </td> <td> <p>25.06</p> </td> <td> <p>0.77</p> </td> <td> <p>2.66</p> </td> <td> <p>22.7%</p> </td> </tr> <tr> <td> <p>DNKN</p> </td> <td> <p>Dunkin' Brands Group</p> </td> <td> <p>59.92</p> </td> <td> <p>5.01</p> </td> <td> <p>4.99</p> </td> <td> <p>16.8%</p> </td> </tr> <tr> <td> <p>GMCR</p> </td> <td> <p>Green Mountain Coffee Roasters</p> </td> <td> <p>10.26</p> </td> <td> <p>0.96</p> </td> <td> <p>1.56</p> </td> <td> <p>20.6%</p> </td> </tr> <tr> <td> <p>PEET</p> </td> <td> <p>Peet's Coffee & Tea</p> </td> <td> <p>68.04</p> </td> <td> <p>2.53</p> </td> <td> <p>5.11</p> </td> <td> <p>22.3%</p> </td> </tr> <tr> <td> <p>SBUX</p> </td> <td> <p>Starbucks</p> </td> <td> <p>26.35</p> </td> <td> <p>2.76</p> </td> <td> <p>6.66</p> </td> <td> <p>18.5%</p> </td> </tr> </tbody> </table>

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 high 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 has slightly better growth estimates and is similarly insulated from foreign economic weakness, its valuation multiples make it unattractive. With a price-to-earnings ratio of 68, it is very expensive.

Caribou Coffee and Starbucks are trading at high P/E ratios. 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.

Know What You Own

With Green Mountain as cheap as it's ever been, many investors are wondering whether this is the end of the former market darling, or the perfect entry point for an enormous rebound. You can find a recommendation for how to approach investing in the company in The Motley Fool’s new premium research report. In it you'll find everything you need to know about Green Mountain, including whether it's a buy at today's prices. Click here for instant access.

 



BillEdson11 has no positions in the stocks mentioned above. The Motley Fool owns shares of Starbucks and has the following options: long DEC 2012 $16.00 puts on Green Mountain Coffee Roasters, short DEC 2012 $21.00 calls on Green Mountain Coffee Roasters, and short JAN 2013 $47.00 puts on Starbucks. Motley Fool newsletter services recommend Green Mountain Coffee Roasters and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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