Green Mountain Likely To Benefit From Weak European Economy

Green Mountain Coffee Roasters (NASDAQ:GMCR), which has consistently traded above $70 ever since its last quarter results came out, will continue to perform strongly, at least in the near term. The company’s most important raw material namely arabica coffee is trading near a three and a half year low. The prices of the three month future deliveries are close to $1.25 a pound currently. ^[1]

Note that there are primarily two types of coffee: arabica and robusta. The former is considered a grade above the latter. All the premiums brand prefer to use the arabica kind and in fact, proudly tout about it. So, for example, you will not find Starbucks serving robusta coffee. Similarly, Green Mountain also exclusively serves arabica coffee.

See our full analysis of GMCR here

Green Mountain’s margins benefited from lower coffee costs to the tune of 290 basis points in the previous quarter. ^[2] As of now, we expect Green Mountain’s gross margins to improve 180 basis points in 2013. However, if the arabica prices continue to test new lows, we could easily the figure rising further. A 100 basis point expansion in the company wide gross margins could push up the stock price by 10%.

So why are the arabica prices so low ?

One of the major factors causing the coffee prices to plummet is the weak macroeconomic environment in Europe. Europe is the biggest consumer of coffee in the world. Sipping an afternoon cup of hot coffee has long been a central part of the European lifestyle, especially in Scandinavia where the per capital consumption of coffee (mostly arabica) is highest in the world. For example, an average Finnish consumes 12 kilograms of coffee in a year compared to 4.3 kilograms by an American ! ^[3]

However, the high levels of unemployment combined with spending cuts are forcing Europeans to trade down to the less expensive robusta coffee. This is the reason why the arabica prices have plummeted and aren’t expected to rebound to the previous highs any time soon.

Besides a weak demand from Europe, the fact that Brazil, the world’s largest producer of coffee, is producing record crops is only pushing down the prices of the arabica variety. Green Mountain, of course, wouldn’t mind that.

The demand for robusta coffee is also driven by the emerging middle class in countries like China, Russia and even India. Coffee drinking culture isn’t a big part of these countries but as their economies grow, people increasingly adopt a Western lifestyle and are ready to spend more on products/services which in a traditional sense would have been considered a ‘luxury’. At lower levels of income, you would expect robusta to be the preferred choice of coffee. As a result, the prices of robusta coffee are relatively firm. In fact, the gap between the two varieties of coffee is pretty low by historical standards.

Recent economic data coming out from Europe hasn’t given any indication of a turnaround either and this is the reason why you see the prices of arabica coffee touching new lows. Given the exceedingly global nature of the American companies, few would benefit from the ongoing European turmoil. Green Mountain is one of them. Moreover, since the company has no presence in Europe, it does not have to bother about the weak economic climate across the Atlantic.

We have a $66 price estimate for Green Mountain Coffee Roasters, which is about 15% lower than the market price.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Coffee Resumes Decline on Vietnam, Bearish Bets; Sugar Retreats, June 18, 2013, bloomberg.com [↩]
2. GMCR 8-k [↩]
3. Worldwide per capita coffee consumption [↩]