Coca-Cola (NYSE:KO) has gotten into the crowded coffee shop business by buying Costa Coffee from Whitbread plc (OTCMKTS:WTCBF). The deal was announced on Friday morning. Coca-Cola stock rose 40 cents on the move on Friday, but finished down for the day. Coca-Cola stock was up around 1% in morning trading today, exceeding $45 per share, little-changed from its close of $44.95 on Thursday.
The price of the deal was 3.9 billion U.K. pounds, or about $5 billion. The acquisition gives Coke a dominant position in the U.K. market, where Costa has over 2,100 stores. Operating 1,280 stores in 31 other countries. Costa also sells vended, packaged coffee under the name Costa Express.
Costa Express will fit in nicely with Coca-Cola’s Japanese coffee product, called Georgia, which I first encountered nearly 30 years ago in Japanese vending machines that served the canned coffee either hot or cold. The deal puts Coca-Cola on a collision course with Starbucks (NASDAQ:SBUX), the world’s dominant coffee chain.
That competition will come first in China, where Costa has 449 shops and Starbucks plans to have 6,000 stores by 2022. The Chinese hot drinks market is expected to be worth $34.2 billion in 2022.
Coffee Is the New Soda
Overall coffee demand is expanding at a pace of 6% per year, while the overall soft drink market is growing much more slowly. The deal will add about $1.5 billion to Coke’s top line, which totaled $35.4 billion last year.
At that price, Coca-Cola stock is a solid dividend play, yielding 3.5% versus the 10-year Treasury yield of 2.9%. It’s the first large deal for Coke CEO James Quincey, an Englishman who took over from Muhtar Kent, a Turk, last year. Coca-Cola stock is up just 15% over the last five years, against a 71% gain by the S&P 500.
Quincey told the trade magazine Beverage Daily that Costa is a “scalable coffee platform across multiple formats and channels,” from vending machines to coffee shops to roast-and-ground coffee, pods, and capsules.
The CEO knows that technology has transformed coffee during this decade. While coffee bean prices have been sliding, and are now below $1 per pound, consumers have become accustomed to paying $10 per pound for artisanal roasted beans, $1 for pods that make a single cup, $2 for a cup of black coffee at a coffee shop, and over $5 for a sugary coffee drink at chains like Starbucks.
As a result, coffee now carries the kind of profit margins that Coke has long gotten on soda, its primary business.
Coffee Is a Crowded Market
Coca-Cola, however, is late to this game.
In addition to Starbucks, which recently licensed its packaged business to Nestle (OTC:NSRGY), there is the German Reimann family’s JAB Holding, which has been buying brands that sell coffee like Einstein Bagels, Krispy Kreme, and Panera Bread. Another player in the space is pod and coffee maker Keurig Green Mountain, whose merger with Dr Pepper Snapple was recently completed, resulting in the advent of Keurig Dr Pepper (NYSE:KDP).
There is also Roark Capital Group, based in Atlanta, whose coffee shop brands include Seattle’s Best, Cinnabon and the Corner Bakery, And of course, Dunkin Brands Group (NASDAQ:DNKN) is also in the category. Dunkin stock shot up over 4% on the Costa deal, as investors speculated that its U.S. distribution and cheap (for Coke) $6.4 billion market capitalization could make Dunkin’ attractive to the soda giant
Coke is betting that its size and distribution can make Costa a global brand across the platforms where coffee is sold, delivering more growth than soda tuck-in acquisitions like Moxie, which Coke recently purchased from one of its bottlers. It remains to be seen, however, whether the Costa deal will move the needle on Coke’s results and Coca-Cola stock.
The Bottom Line on Costa and Coca-Cola Stock
By turning commodities into drinks, drinks into experiences, and the experiences into restaurants, Starbucks helped turn coffee into a product that is very cheap to make but can deliver high profit margins.
Coke seems to believe that Costa can move the needle on its its bottom line. But even if that doesn’t come to pass, the high dividend yield and rock-solid stability of Coca-Cola stock make it an attractive dividend play.
Dana Blankenhorn is a financial and technology journalist. He is the author of a new mystery thriller, The Reluctant Detective Finds Her Family, available now at the Amazon Kindle store. Write him at firstname.lastname@example.org or follow him on Twitter at @danablankenhorn. As of this writing he owned no shares in companies mentioned in this story.