Plunging Coffee Prices Don’t Make Coffee Stocks a Buy

by Dan Burrows | November 6, 2012 6:15 am

So much for the big coffee-price scare[1] of early autumn.

A robust harvest of premium Arabica beans out of Brazil, the world’s biggest producer, and a better-than-expected season from No. 2 Arabica grower Colombia amid essentially stagnant demand have the price of coffee futures falling sharply.

Back in early September, coffee drinkers and companies were jittery about a sharp price spike caused by concern that the harvest in Colombia would be a dud. The Andean nation has suffered through a couple disappointing seasons as heavy rains tied to the La Niña weather phenomenon hurt the harvest. This year, El Niño, which typically leads to drought, has been the big concern.

But the picking season in Colombia and Central America is coming along just fine, and yields should easily top the output of the past few years. Indeed, at the end of summer, Colombian coffee production had jumped more than 20% over last year, exports had jumped nearly 60% and output had increased for five consecutive months.

That has futures for Arabica beans trading at their lowest levels since June, and headed for more weakness. Heck, the reason we brushed off the coffee-price scare of a couple months ago was that coffee has been about the worst-performing futures contract over the past 52 weeks. Java has fallen 34% in the last year and nearly 10% in the past month alone.

If nothing else, that has coffee sellers and roasters set up for some very easy year-over-year comparisons.

But that doesn’t automatically equate to upside in shares of companies like Starbucks (NASDAQ:SBUX[2]), Green Mountain Coffee Roasters (NASDAQ:GMCR[3]), Dunkin’ Brands (NASDAQ:DNKN[4]) or J.M. Smucker (NYSE:SJM[5]), whose brands include Folgers, as well as Dunkin’ coffee sold in supermarkets and stores. (Beloved Peet’s Coffee is out of the game, though, as it just sold itself to privately held JAB Holdings.)

After all, company management and the market has been pricing in the effects of lower input costs for a while now.

Starbucks, for example, said it expects any benefit from lower coffee prices to be offset by increases in investment spending, notably for the continued rollout of its Verismo single-cup espresso brewer[6].

Green Mountain, whose K-Cup system is being targeted by Starbucks’ Verismo, hiked prices in 2011 to cope with rising input costs, note analysts at Trefis. True, if the company can lift prices again even as coffee prices abate, there should be a nice pop in the stock, Trefis notes. But that’s a big “if” in a super-competitive market where further pricing power is going to be much harder to come by.

Interestingly, Dunkin’ Brands could get a boost from lower coffee prices, even though the price of beans has little bearing on its cost structure. Chalk it up to perceptions rather than reality, note analysts at Williams Capital. After all, the stock gets hurt for no good reason when prices rise.

“The investment community is very concerned about the prospects of higher coffee prices and could punish the shares of the company, despite the fact that Dunkin’ Brands is not directly exposed to the commodity since the majority of their units are franchised,” the analysts write in a note to clients.

Smucker could benefit from lower prices next year, but for the current period, margins already are on track for contraction. Nearly 50% of Smucker’s profits are forecast to come from U.S. retail coffee sales this fiscal year, according to research from Hilliard Lyons, but segment profit margins are expected to decline to 23.6% from 27.8% a year ago, despite lower costs.

I wouldn’t buy the coffee stocks on the sharp decline in futures prices alone. That news is already baked into shares and expectations. In many cases, management has already targeted any savings for investment elsewhere, or is dealing with competitive pricing pressures and top-line softness.

On the other hand, if you already own the group, at least it’s one less thing to worry about.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

Endnotes:
  1. coffee-price scare: http://investorplace.com/2012/09/dont-sweat-panicked-coffee-headlines-sbux-gmcr-dnkn-peet/
  2. SBUX: http://studio-5.financialcontent.com/investplace/quote?Symbol=SBUX
  3. GMCR: http://studio-5.financialcontent.com/investplace/quote?Symbol=GMCR
  4. DNKN: http://studio-5.financialcontent.com/investplace/quote?Symbol=DNKN
  5. SJM: http://studio-5.financialcontent.com/investplace/quote?Symbol=SJM
  6. continued rollout of its Verismo single-cup espresso brewer: http://investorplace.com/2012/11/3-reasons-why-starbucks-stock-will-be-even-better-in-2013/

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