Coffee Prices Are Tumbling and Profit Margins Are Soaring at This Company

It may be hard to believe, but coffee prices have fallen 40% over the past year. According to the World Bank, the price of a kilogram of Arabica coffee has plummeted from roughly $6.50 at its peak in 2011 to $2.91 currently.

Coffee Arabica Price Chart

Coffee Arabica Price data by YCharts

Yet I can almost guarantee the price for the cup of coffee you buy every morning has not decreased 40% over the past year. It probably has not even decreased in price at all, which means that the store you buy that cup of coffee from is making more money than ever.

Falling input prices equals rising profit margins
For companies such as Starbucks (NASDAQ: SBUX  ) , Dunkin Brands (NASDAQ: DNKN  ) , and Green Mountain Coffee Roasters (NASDAQ: GMCR  ) , coffee constitutes a major portion of operating expenses. Thus, with coffee prices declining, these companies stand to make more and more on each cup.

Not surprisingly, since 2011, when coffee prices peaked, all three of these companies' net profit margins have risen.

Coffee Arabica Price Chart

Coffee Arabica Price data by YCharts

Why coffee prices are falling
The reason behind coffee's long decline is nothing other than supply outweighing demand. In September, the Green Coffee Association announced that U.S. stocks of un-roasted coffee in August rose 2.4% from the previous month to approximately 5.6 million 60-kilogram bags. This represents the most coffee stored in domestic warehouses since July 2009, the last time coffee prices were this low.

While coffee demand is rather constant, global supply has been growing steadily throughout the past couple of years, and is expected to continue to grow at least through mid-2014.

Why? Partially because of Brazil, which produces roughly one-third of the world's coffee. The country has experienced a surplus of rainfall recently, which sets the stage for a good harvesting season in the country, which will begin mid-year 2014.

In July, Goldman Sachs cut its forecast for Arabica coffee futures from $1.45 per pound to $1.30 per pound for the next 12 months. If correct, this would not represent any further declines in the commodity, but would by no means represent any sort of significant rebound in prices.

How to capitalize
Thus, with coffee prices projected to remain near historical lows, how should investors capitalize on this trend? All three of those companies mentioned above stand to benefit from depressed coffee prices. They all have outperformed the broader market recently, and should continue to outperform, driven by rock-solid fundamentals.

DIA Chart

DIA data by YCharts

Starbucks is expected to increase its earnings per share 80% from 2012 to 2015, from $1.79 to $3.20. With this caliber of expected growth, it is no surprise the company carries a 36.9 price-to-earnings ratio. The company pays out a dividend yielding 1.1%.

Green Mountain Coffee Roasters, which carries a price-to-earnings ratio of approximately 26.0, is projected to grow its EPS nearly 90% from 2012 to 2015, from $2.28 to $4.29. However, the company does not pay out a dividend.

Dunkin is forecasted to experience 125% growth in its EPS from 2012 to 2015, from $0.93 to $2.11. This expected growth is reflected in the price-to-earnings ratio of 38.2. In addition, the company trades with the largest dividend out of the three, yielding 1.7% annually.

The Foolish bottom line
Ever since coffee prices began to decline back in 2011, companies in the coffee industry have fattened their profit margins. With analysts expecting coffee prices to remain relatively depressed for the near-future, investors in Starbucks, Dunkin, and Green Mountain Coffee should continue to benefit.

All three of the companies possess sterling fundamentals, but if I was forced to pick one I would prefer Green Mountain Coffee, as in terms of the price-to-earnings ratio it is by far the cheapest. Yet all should continue to outperform the overall market if coffee prices remain depressed.

One thing I would not count on is the price of your morning cup of coffee going down any time soon. 

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