After staying at tepid levels for more than a year-and-a-half, coffee prices are rising once again. In the last four months, arabica coffee prices have almost doubled from $1.06 per pound in November to more than $2 per pound currently.  Drought conditions in Brazil, the world’s biggest producer of arabica coffee beans, have raised concerns about the production of coffee in the country. As a result, coffee prices are hovering near their two-year high.
Starbucks Corporation (NASDAQ:SBUX) is one of the companies that is expected to weather the storm relatively well. The recent spike in coffee prices shouldn’t affect Starbucks’ profitability since the company already has a year worth of coffee locked in at earlier prices. Starbucks’ CEO, Howard Schultz, also mentioned that the company doesn’t intend to raise prices at its stores across the U.S.  Low coffee prices benefited Starbucks to the tune of $97 million during fiscal 2013 (Oct’12-Sept’13). For the ongoing fiscal year, Starbucks expects a benefit of another $110-120 million as a result of subdued coffee prices. 
We have a $74 price estimate for Starbucks, which is in line with the market price.
Green Mountain Has Different Dynamics
On the other hand, Green Mountain Coffee Roasters’ profitability could be impacted to a greater degree as a result of the high coffee prices. Green Mountain is more sensitive to coffee prices than Starbucks or Dunkin’ Donuts since coffee constitutes a lower proportion of the total costs for a coffee house or restaurant chain since it sells the products at a higher price. On the other hand, the price of a K-Cup is considerably lower when compared to a coffee cup at a cafe. Thus, there exists a significant downside risk to Green Mountain’s profits.
The cost of commodities accounted for approximately 62% of the revenues last year. Green Mountain’s profits soared during 2013, primarily due to lower coffee costs, with gross margins rising more than 400 basis points on a year-over-year basis. Similar to Starbucks, Green Mountain had also locked in the future supply to protect the company against price fluctuations. As of December 2013, the company had $269 million in coffee price purchase commitments.  However, this translates to less than three months’ coffee supply for the company. Therefore, if the coffee prices don’t revert to previous levels, there could be some decline in Green Mountain’s margins.
On a similar note, Starbucks’ packaged segment could also witness some margin erosion. This segment is most sensitive to the cost of coffee since the raw material costs are higher (as a % of total costs) for packaged products (vs coffee sold at Starbucks stores). As was the case with Green Mountain, margins widened significantly in 2013. Going forward, the margins shouldn’t deteriorate in the near term because the company has already locked in supply for a year, as already specified. However, in the medium to long term, we could see some margin decline, in case coffee prices continue to remain persistently high.
Sales of Starbucks’ channel development segment consist of packaged coffees and teas, K-cups and brewers that are available in grocery and retail stores. The segment is growing at a brisk pace and already accounts for about a tenth of the total sales. In terms of value contribution, we estimate that the division contributes a little more than 10% to the company’s stock price. Therefore, any downside risk arising as a result of high cost of raw materials shouldn’t affect the overall company significantly.Notes:
- Coffee Prices Ease Off of Two-Year High, March 12, 2014, foxbusiness.com [↩]
- Starbucks CEO says drink prices won’t go up despite spike in coffee bean costs: Fox Business interview, March 11, 2014, foxbusiness.com [↩]
- Starbucks Predicts $120M Benefit from Falling Coffee Prices, November 19, 2013, ibtimes.com [↩]
- GMCR 10-Q [↩]