By Eric Volkman
August 25, 2012
Starbucks (Nasdaq: SBUX)
is a company heavily dependent on one commodity: raw arabica coffee. It's nice,
then, that prices for those beans have generally been dropping in recent
months. And based on futures contract data, that trend looks as if the trend
will continue. So that seems a clear win for the company and other arabica
buyers. But not all business advantages can be exploited equally, and Starbucks
might not be the company best positioned to capture the opportunity.
Drier
and cheaper
The
prolonged dry weather badly affecting crops in the U.S. has been beneficial for
certain commodities abroad, most notably coffee. An unusually heavy bout of wet
weather affecting output in java-growing countries several years ago is largely
over, bringing production back to former levels. Forecasts indicate that
production in Colombia, for example, could reach a half-decade high of 9
million bags (approximately 1.2 billion pounds) next year; 2011's haul of 7.8
million (1 billion pounds) was the lowest in 35 years.
Prices
have gone south thanks to the increased supply. These days, a pound of coffee
on the commodities market will run a buyer around $4.20 per kilogram, or $1.91
a pound. That's quite a far way down from the weather-influenced price spike of
last year, when java changed hands at prices in excess of $6.60 per kilo ($3
per pound).
In
2011, Starbucks paid an average price of $2.38 per pound for its coffee,
meaning at current rates the company is saving around 20% on the costs of that
most crucial input. And this equals a lot of dosh -- Starbucks bought more than
428 million pounds of raw beans that year, meaning a total cost of $1 billion
or so. If today's prices were applied, that figure would drop to around $820
million.
Unfortunately
for Starbucks regulars like your humble correspondent, the company is loath to
cut the prices of its beverages. But the story is different for shareholders --
all things being equal, fewer costs should mean higher profits and more money
in the company's pocket.
Avoiding
the espresso machine
But not
necessarily if you're an international operator, as Starbucks has increasingly
become. Europe's protracted economic slowdown has eviscerated the market for
luxury goods, and many newly un- or under-employed Europeans consider coffee to
be a luxury at the moment. So they're cutting down on their traditional morning
bracer of espresso or the daily cappuccino. These, however, are the drinks made
from the higher-end arabica beans, and arabica is the type Starbucks buys
exclusively.
Overall
coffee-bean imports to the hardest-hit European economies have dropped
significantly. In the most recent October-to-April period, they were down by
6.6% year over year in Spain and nearly 3% in Italy, two nations renowned for
their high java consumption. This wasn't offset by two of the continent's
biggest coffee quaffers, Germany and France, which saw meager increases of 0.4%
and 1.3%, respectively. Those four nations, incidentally, together imported
around 5.4 billion pounds of coffee during the period, compared with 3.4
billion for America.
Many
Europeans are replacing their beloved craft beverages with more downscale
coffees made from the less favored robusta bean. This change in habit is
affecting the raw coffee market; the price gap between arabica and robusta has
narrowed to levels not seen in years.
Domestic
or diversified
Although
Europe is only a small part of Starbucks' operations at the moment (8% of total
stores worldwide), its participation has grown over the years. The number of
stores on the continent increased by 15% from Q1 2009 to Q3 2012, the most
recent quarter, while the figure dropped by 5% for the company's American
branches.
Eight
percent isn't a big number, but it's large enough to make an impact. Flat
growth in same-store sales in Europe (plus the Middle East and Africa, as
Starbucks lumps all of them into one region) was one of the reasons the
company's most recent quarterly results disappointed the market.
"Europe," CFO Troy Alstead was quoted as saying, "continues to
be our most challenged part of the world by far."
So
maybe the better way to play the drop in arabica prices is to place bets on the
more domestically focused purveyors of the bean. Green Mountain Coffee Roasters (Nasdaq:GMCR ) , a onetime
market star that's lost much of its shine, could benefit from better margins.
In its most recent quarter, the company grew revenue strongly (by 21% year over
year), but gross margins narrowed slightly.
Alternatively,
a stock with a strong coffee presence yet more hedged with food offerings might
be a good way to go. There's always the durable McDonald's (NYSE: MCD ) , which,
after rolling out its McCafe offerings several years ago, takes in an estimated
4% of total revenue from espresso-based drinks, around double the rate of five
years ago. That would equate to a little more than $1 billion out of the
company's 2011 top line of $27 billion.
Dunkin
Brands (Nasdaq: DNKN ) also uses
arabica beans exclusively and pours an awful lot of coffee -- almost 1.5
billion cups of the stuff every year. Its flagship Dunkin' Donuts outlets sell
food items to absorb the java, while its Baskin-Robbins ice cream parlors help
offset the parent company's reliance on the hot brown liquid.
Of
course, there are Starbucks' direct competitors. Both Peet's and Caribou (Nasdaq:CBOU ) have seen
their gross margins slip over the past few fiscal years and could use a break
in the form of lower-cost raw coffee.
Every
company likes cheaper input prices, and Starbucks will almost certainly benefit
from less pricey arabica. But they won't be the only one enjoying that
advantage, so it's worth looking around for rivals that might be better placed
to exploit it.
Read more on Fool