Coffee’s Curse

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

“Tall, Grande or Venti?” the barista asked with a smile. After taking a moment to contemplate how long my day would be, I decided upon a Venti. I removed three dollars and change from my pocket, and placed it on the counter. Thank you, Starbucks. Today will be a good day.

Coffee is a morning institution among working adults. The average price for a cup of brewed coffee is $1.38, but many Americans are willing to pay much more for a “premium roast.” As you can see from my experience, I’ve been suckered into developing expensive taste buds.

It's bean a while

Coffee bean prices have fallen 54% in the past two years. In 2011, coffee hit a 14-year high, selling for over $3 a pound. Today, a pound fetches about $1.22. The drop in price can be attributed to record harvests in the coffee growing nations of Brazil and Colombia. An increase in South American supply led to a drop in demand, bringing prices down with it.

Unfortunately for consumers, the falling price of the coffee-beans probably won’t translate to a cheaper “cup of Joe.” Morning customers of Starbucks (NASDAQ: SBUX), Dunkin Donuts (NASDAQ: DNKN), and McDonald’s (NYSE: MCD) shouldn’t count on it.

The curse

Big name roasters purchase coffee beans long before harvest season via futures. These contracts limit risk for both farmers and buyers. Because futures contracts are written so far in advance, price declines are often muted, meaning buyers might not see the discounted beans for months.

Even with cheaper beans, coffee drinkers aren’t likely to be the beneficiaries of reduced prices. A brewer’s brand name carries pricing power. A customer going to Starbucks expects a higher priced, premium coffee. Someone going to McDonalds expects an inexpensive cup of coffee.

Additionally, American consumers are not exactly price sensitive to coffee: a marginal price increase will not break morning drinkers’ habits (addictions).

Grounds to buy

Contrary to popular belief, coffee does not stunt growth. Well, at least in the case of the three biggest coffee brewers in America. Starbucks plans on opening 1,300 new stores in 2013, while Dunkin Donuts aims to launch about 300 stores in the U.S alone. McDonald's already has over 13,000 stores in the United States, and since its introduction in 2001, its McCafe has grown to account for over 5% of total sales.

Coffee brewers are looking (and smelling) good. On top of high growth, investors should take note of these companies’ income statements. If brewers keep prices consistent while futures fall, it should mean one thing: higher margins. That’s great news for shareholders, because higher margins lead to larger profits.

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A Kraft brew

On-the-go coffee consumers are out of luck, but there are some advantages to brewing your own coffee. Prepackaged coffee makers J.M. Smucker (NYSE: SJM) and Kraft Foods (NASDAQ: KRFT) dominate grocery store shelves.

When you hear J.M. Smuckers, you probably think of jelly. On top of jams, preserves and hundreds of other products, Smuckers sells prepackaged coffee under the brand name Folgers and is licensed to sell Dunkin Donuts brand coffee.

Unlike brewers, Smuckers lowered its prices on coffee three times since futures plummeted. The reductions have compounded, and Smuckers products now cost customers 6% less. Consumers responded, last quarter Folger’s sales increased 3% and Dunkin Donut’s sales grew by 11%.

To stay competitive, Kraft Foods followed suit, dropping its coffee prices by 6% as well. Kraft sells its coffee under the brand names Maxwell House and Yuban. Kraft holds the 4th largest market share with 6.8% after Green Mountain Coffee Roasters and Starbucks.

Coffee sales are up across the industry, providing a boost to most manufacturers’ share prices. Unfortunately, Kraft has fallen due to problems related to its spin-off from Mondelez International. The company is working through an inventory buildup, but saw sales slide last quarter after Kraft reported an 11% drop in revenue. As the company begins to find its feet again, decreasing coffee prices might just pick this stock back up.

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The fine grind

According to the Wall Street Journal, coffee prices are quickly falling towards the cost of production. At that point, it would cost farmers more to grow coffee than to not grow it. Logically, prices will rise or farmers won’t grow.

Worldwide coffee demand is increasing. Eventually reserves will decrease, and prices will rise. However, until that day comes, high growth and low costs make coffee brewers and packagers very attractive investments. The money you spend on morning coffee might just find its way back into your pocket.

This article was written by Joshua Sauer and edited by Chris Marasco. Chris Marasco is Head Editor of ADifferentAngle. Neither has a position in any stocks mentioned.The Motley Fool recommends McDonald's and Starbucks. The Motley Fool owns shares of McDonald's 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!

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