Building a Coffee Empire
Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
On Dec. 17, investment firm Joh. A. Benckiser Group announced an agreement to purchase Caribou Coffee (NASDAQ: CBOU) for $16 per share in cash, or roughly $340 million. The purchase price values the coffeehouse chain at 3.3 times book value and 39 times EPS. Benckiser obviously likes the industry’s growth prospects, with existing stakes in Peet’s Coffee & Tea and D.E. Master Blenders.
What’s Going On Here?
The international coffee trade continues to grow, as rising incomes in developing nations are leading to an expanded customer base for roasters. The International Coffee Organization, an industry trade group, estimates that 146 million bags will be sold in the 2012/2013 crop year, an 8.4% increase over the prior year. Here in the U.S., the coffee business is also doing well and continues to enjoy a leading position as the morning beverage of choice. According to the National Coffee Association, 54% of adult Americans drink coffee on a regular basis and they spent roughly $40 billion on it in 2010. However, the small coffeehouse chains are seeing profit pressures from a number of factors, including the following:
The Empire: Starbucks (NASDAQ: SBUX) dominates the business with its 18,000 stores worldwide. It is a juggernaut with more than $13 billion in annual sales and leading positions in retail, foodservice, and grocery channels.
Single-Serve: While drip coffeemakers have been around for years, the newer single-serve machines are providing better quality, convenience, and choice for the at-home market. Green Mountain Coffee Roasters (NASDAQ: GMCR) is the domestic leader in the segment with its Keurig and Vue products, although Starbucks, Nestle, and Kraft Foods also participate in the market. In FY2012, Green Mountain reported sales of 8.6 million Keurig machines, a 49% yearly increase in sales volumes for its brewers.
Uncle Sam: The Food Safety Modernization Act, passed by Congress in 2010, provides improved regulation over the nation’s food supply, but increases companies’ compliance costs. The new requirements of the law include prevention-based controls, certification of imported food safety, and FDA recall authority over all products. While implementation dates have been pushed out, the law will favor the larger firms with staff who can manage the reporting requirements.
What’s the Value?
Caribou is the second largest U.S. coffeehouse chain, with 610 stores in 22 states and 10 international markets. Through the first nine months of FY2012, the company reported a small 2.1% increase in sales, but adjusted EBITDA fell 6.1% compared to the prior year period. While comparable store sales rose at a low single digit rate, operating margins have been negatively impacted by rising commodity and occupancy costs. In addition, sales in Caribou’s commercial segment were weak, declining 7.0% versus the prior year, as it experienced declines in sales of its portion packs for single-serve machines.
Benckiser sees value in the company’s large base of stores and potential growth in the wholesale market. This segment has been a focus for the company, accounting for 19% of total sales in FY2012 versus only 5% in FY2007. While competition in the foodservice and grocery markets is obviously significant and shelf space is limited, the higher margins and larger market opportunity are worth the investment.
The Next Opportunity
Caribou could potentially get a higher offer, but investors should probably look elsewhere in the sector for good returns. An interesting opportunity is presented in the shares of Einstein Noah Restaurant Group (NASDAQ: BAGL). Einstein is the nation’s largest operator of bagel cafes and gets 10% of its annual sales from coffee. It operates 797 restaurants under the Einstein Brothers, Noah, and Manhattan brands.
The company has spent the past few years restructuring its business after its initial fast growth in sales and store openings led to financial difficulties. The focus of its current strategy has been a shift from company-owned stores to franchised and licensed stores, with a specific focus on the airport and hospital markets. While the total number of restaurants has risen 26.3% over the past four years, the number of franchised and licensed restaurants has increased by 69.9%. The new strategy should ultimately benefit the company’s profit margins, as these stores have lower capital requirements and higher average sales than company owned stores.
In its latest fiscal year, Einstein reported that sales grew by 5.1%, but adjusted EBITDA declined by 1.8% compared to the prior year. While sales benefited from higher comparable stores sales and 40 additional restaurants, operating margins were hurt by rising commodity and marketing costs. In FY2012, though, the company’s results have improved with increases in sales and adjusted EBITDA of 2.6% and 23.5%, respectively, over the prior year period. Sales benefited from stable average prices and a 20% jump in Einstein’s catering business. Meanwhile, both gross and operating margins were higher as the company limited its exposure to volatile commodity prices and outsourced some of its food ingredient production. While the retail food business is always competitive, Einstein's reasonable 16 P/E multiple and shareholder-friendly management make it a good buy for any investor's portfolio.
rghanley 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 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!