Starbucks Raises Coffee Prices: Boost To Margins And Revenue Growth

SBUX: Starbucks logo

Starbucks Corporation (NASDAQ:SBUX) has decided to raise the prices of its coffee menu, responding to soaring commodity prices, especially coffee beans. The price of Arabica coffee beans has surged almost 100% from a level of 106 cents per pound to around 220 cents in mid April, due to tight supply as a result of prolonged drought in Brazil, followed by recent floods.((Coffee futures, July contract, 2014)) However, the prices dropped back to 170-180 cents per pound in the month of June, but are expected to rise again due to increasing demand for premium coffee beans and the forecasts regarding the early outbreak of El-Nino, the oceanic disturbance, that can intensify the already adverse weather conditions in Southern Brazil. [1] Companies such as Starbucks (NASDAQ: SBUX), Dunkin’ Brands (NASDAQ: DNKN), Peet’s Coffee and Keurig Green Mountain (NASDAQ : GMCR), that are majorly dependent on coffee for revenues, are facing a tough period adjusting to rising input costs.

Starbucks had an excellent second fiscal quarter recording its 17th consecutive quarter with above 5% comparable sales growth. The highlight of the second quarter was its noteworthy comparable sales growth in China and Asia-Pacific (7%), as well as Europe and the Middle East (6%). Operating margins expanded by 130 basis points to 16.6%, primarily due to favorable commodity costs. ((Starbucks Q2 earnings transcript, March 24, 2014))

Starbucks feels that the price hike will be barely noticeable considering the coffee enthusiasts can already afford the lofty prices and the increased prices won’t have much of a dent on customer visits.

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We have a $76 price estimate for Starbucks, which is 2.5% below the current market price.

See our full analysis for Starbucks Corportion

Starbucks has always been known for its above-average pricing. The company is raising prices on some of its drinks by 5 to 20 cents, whereas its packaged coffee sold in supermarkets and other retail stores will rise by $1 (8%) to $9.99 per bag as compared to Folger’s 9% and Maxwell house’s 10% hike. Company’s spokesman Zack Hutson mentioned that the price of grande and venti brewed coffee will increase by 10 to 15 cents, whereas tall and venti lattes will cost 10 to 20 cents more. [2]

Inflation has not only impacted coffee prices but its impact is being felt in food-at-home items and the cost of milk is up for the seventh month in a row. These companies have no choice else to increase prices and as long as customers are comfortable in buying their products, the price hike will be slowly passed on to them. Two months back, according to Starbucks’ CEO, Howard Schultz, the company was not planning to raise its coffee menu prices despite the sharp rise in commodity costs. [3] Now when its competitors have raised the coffee prices and customers are aware of the reasons of the hike, the possibility of losing the customer traffic is nearly negated for Starbucks. [4] The reason coffee lovers go to other chains such as Dunkin’ Donuts and Peet’s Coffee is their lower priced coffee and now when they have  raised prices as well, the customers might as well pay for better quality Starbucks coffee.

  • Revenues & Margins To Improve

Looking at the current coffee prices in Starbucks, this hike seems insignificant to coffee consumers. However, considering the seasonality trend, the company generates 50% of the total revenue in the second half of the calendar year. Consequently, this move might positively boost company’s revenue growth for the next 6 months. According to our estimates, beverage spend per customer visit for the year 2013 was around $4.25 for company-operated stores. If the company maintains the customer traffic, this figure might reach $4.30 for the year 2014 and further higher in 2015.

Moreover, in its latest Q2 earnings transcript, the company mentioned its one year worth of protection on inventory and contracts. To hedge against rising coffee prices, Starbucks virtually has locked all of its coffee needs for 2014 and around 40% for fiscal 2015 at slightly favorable prices. Now that when its input costs are nearly fixed at favorable levels, taking into account the company’s brand appeal, ability to maintain its customer base and lure more traffic through its in-store amenities, we might even witness margin expansion in those quarters.

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  1. El-Nino: Global Food Supply Disruption []
  2. Starbucks: price of venti latte rises []
  3. Howard Schultz, Fox Business interview []
  4. Why Starbucks has an edge over competitors despite rising coffee prices []