3 Ways to Play Coffee

I drink an awful lot of coffee, which puts me right in with most Americans, I suspect. As a country, we consume over 400 million cups of coffee a day. As investors, we've seen lots of great opportunities over the past few years to get in on the growing coffee culture, and now is still a good time to check them out. There are three main ways to play coffee, and we'll look at a leader in each space. First, we can buy it in a store. Second, we can make it at home the old-fashioned way. Finally, we can devote an acre of counter space to a machine that makes a cup at a time. Regardless of your chosen input method, coffee still makes an excellent investment.

Get your fix on Route 66 -- or any route, really
There are few stores that can boast more locations than Starbucks (NASDAQ: SBUX  ) , and the company has been so successful that every restaurant now seems compelled to try their hand at coffee. Dunkin' Brands (NASDAQ: DNKN  ) is in on the action, as is McDonald's. But neither of them can touch the coffee market domination that comes with over 18,000 locations across the world, with almost 13,000 in the US.

Last fiscal year, which ended in October, the company grew earnings per share by 24%, in part by growing comparable-store sales by 6% worldwide. That consistent foot traffic was helped out by some new product lines and acquisitions. In fact, 2012 was one of the busiest years in recent memory for Starbucks. Early in the year, the company purchased La Boulange, a bakery based in San Francisco. Then, in the summer, it brought in a new line of green-coffee-based drinks, which have helped drive customers into the store.

All of this was set against the unfolding story of a brewing single-serve home-machine battle. As it turns out, the battle was overhyped -- I know, I fell for it. In 2013, I'm looking for strong sales of Starbucks' Verisimo brewer, and an increase in the visibility of some of the newly acquired lines. Apart from that, I expect Starbucks to post 2013 results that almost match 2012's. One of the company's long-term issues is going to be green coffee prices, but that will affect all three of these companies, so I'll address it at the end.

Home again
If you don't swing by Starbucks, you probably just make coffee at home. That means you probably have a big old jar of J.M. Smucker's (NYSE: SJM  ) brand Folgers coffee sitting in the cupboard. Folgers was the top traditional brew coffee in a Harris poll conducted earlier this year, and it's the single most important product in Smucker's arsenal. Last quarter, U.S. coffee sales accounted for 38% of total revenue.

Even if you're not a Folgers drinker, you might be buying Dunkin' Donuts packaged coffee -- which, believe it or not, is a Smucker product -- or any of the company's K-Cup brands. Smucker's reach into the coffee world is impressive, and the growth of coffee demand helped the company push earnings per share up 21% last quarter. For fiscal 2013, which ends next spring, the company expects to continue its current pace of high-single-digit sales growth. Smucker is a nice stable way to play the coffee scene without having to worry about trends. But if you're looking for growth, risk, and riding the wave right to the bitter end, maybe you're a Green Mountain Coffee Roasters (NASDAQ: GMCR  ) investor.

Single-serve it up
Early in the year, Green Mountain was the industry whipping boy. Everyone saw the end of its dominance when the company's major patents expired. Everyone was doubtful of its ability to innovate. Everyone thought it was going to be crushed in the fourth quarter. That's not happening, so instead everyone is talking about how much they love Green Mountain. I'll admit having shifted my view on the company as well.

Earlier this year, I thought it had no chance and that it would get crushed by the release of the Verisimo system from Starbucks. As it turns out, the two systems seem to be symbiotic, with Green Mountain's paving the way for Starbucks' and Starbucks' system making Green Mountain's seem like a good value. Whatever my outlook is, the company has done well. This year, income is up, sales are up, everything is up. I think 2013 is going to bring similar results. The single-serve brewers are still catching on, and as more and more brands get on board, they have the potential to keep running.

Having said that, I still don't like Green Mountain, due to its incredibly thin moat. The company will still make money, and will continue to lead the pack next year, but there is little in the way to stop other companies from getting in the game. The biggest block is Green Mountain's agreements with brands to produce the K-Cups for its machines. In summary, I see it as a good stock for next year, but not forever.

The bottom line
I want to quickly touch on commodity prices for all of these companies. The best coffee is grown at high altitudes in countries with a dry and a wet season. As the climate changes, growers are finding that they must move up the mountains that they're growing on, in order to escape the warm weather, which is detrimental to coffee. As that trend continues, growers will continue to lose space at the lower elevations, and coffee growing areas will continue to shrink.

That's going to drive up green coffee prices over the next decade and put a dent in everyone's bottom line, or signal an increase in consumer prices. The companies best set to weather that coming storm are the ones, like Smucker, that use cheaper, easier-to-grow robusta beans in addition to the higher-end Arabica beans. Coffee investors need to keep a sharp eye on those prices, as even one bad growing season can impact costs.

Even though I'm not a fan of the company, people smarter than me have come around to Green Mountain. You can find our top analysts' recommendation for how to play it in our new premium research report. In it you'll find everything you need to know about the company, including whether Green Mountain is a buy at today's prices. Click here for instant access.


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