Perk Up! Coffee’s Starting to Brew Big Profits

by Dan Burrows | June 6, 2013 1:11 pm

Judging by the action in J.M. Smucker’s (SJM[1]) stock Thursday morning, you’d think it was in a jam.

It’s not — and the coffee-dependent company’s quarterly results bode well for the broader industry and purveyors of brewed java in particular.

SJM tumbled Thursday despite reporting a 13% gain in fiscal fourth-quarter income that beat Wall Street’s average estimate by a whopping 13 cents a share. True, revenue slipped 1%, but that matched analysts’ average forecast. No harm, no foul.

The culprit for the selloff early in the session was SJM establishing a full-year earnings forecast slightly below the Street’s estimate. Once the market recalibrates its expectations, it can focus on some truly good news in the cost structure and margin story.

What’s interesting is the way in which Smucker drove its unexpectedly large increase in profits, and what it could mean for other companies’ bottom lines.

Despite being known for its eponymous jellies and jams — and perhaps Jif peanut butter — Smucker derives more than 40% of annual revenue from its U.S. retail coffee business, which includes Folgers, Millstone, Dunkin Donuts bags sold in stores and Cafe Bustelo, among other brands.

Smucker essentially makes or breaks its numbers with the coffee business. Those are the results that boosted the quarter — and the reason for the better-than-expected results is positive for anyone else selling coffee.

Revenue slipped slightly because the company cut average selling prices, but profits rose sharply because costs fell by an even greater amount than revenue. The reason: sharply lower prices for green coffee.

Indeed, profits from the U.S. retail coffee segment popped 18% even as sales fell 1.2%, thanks to “significantly lower” prices for raw beans year-over-year, the company said in a media release.

After a huge run-up in 2010 and 2011 partly due to poor harvests in Colombia — the world’s largest producer of mild washed Arabica beans — coffee prices have gone into free fall.

A rebound in production from Colombia and bumper harvests in Brazil, the world’s biggest coffee grower, have made supplies so robust that even a coffee fungus ravaging key Central American growers couldn’t stop the slide in bean prices.

Coffee futures are down about 11% year-to-date and have hit a three-year low. Have a look at the chart below, courtesy of Nasdaq, and you’ll see that prices have tumbled by more than half since their 2011 peak:

COFFEE CHART Perk Up! Coffee's Starting to Brew Big Profits

Smucker passed some of those savings onto customers — slicing list prices on average by 6% — and still was able to realize higher profit margins on its coffee brands.

That’s good news for other companies that sell bagged coffee to consumers, such as Green Mountain Coffee Roasters (GMCR[2]) and Kraft Foods’ (KRFT[3]) Maxwell House and Gevalia brands.

It should be even better news for slingers of the finished product, like Starbucks (SBUX[4]) and Dunkin Brands (DNKN[5]), which don’t typically pass lower input costs along to customers.

The plunge in coffee prices might be hurting growers and traders, but it’s been a rare case of a win-win for both U.S. sellers and consumers.

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

Endnotes:
  1. SJM: http://studio-5.financialcontent.com/investplace/quote?Symbol=SJM
  2. GMCR: http://studio-5.financialcontent.com/investplace/quote?Symbol=GMCR
  3. KRFT: http://studio-5.financialcontent.com/investplace/quote?Symbol=KRFT
  4. SBUX: http://studio-5.financialcontent.com/investplace/quote?Symbol=SBUX
  5. DNKN: http://studio-5.financialcontent.com/investplace/quote?Symbol=DNKN

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