Will Your Favorite Coffee Cost More in 2014?

With coffee prices reaching low levels unseen in years, there’s market sentiment that coffee prices could pick up in 2014.

Jan 4, 2014 at 7:00AM

As 2014 approaches, coffee industry analysts and investors are betting that coffee prices are gearing up for a turnaround after hitting multi-year lows in recent months. Will the rising cost of coffee beans mean higher coffee prices at your local cafe?

The Wall Street Journal looked at prices for arabica coffee beans, known for producing better tasting coffee, and lower quality robusta beans and found that the price differential between the two beans narrowed to just $0.28 per pound in December. This is the narrowest price gap seen since October 2008. The drop in the price of arabica beans is in part due to an abundant crop out of South America hitting the market. In November, the price of arabica hit a seven year low.

As the price difference narrows, roasters choose higher quality beans
The narrower the difference in price between the two types of beans, the greater the tendency for roasters to use more arabica beans in their coffee blends. Global beverage strategist Ross Colbert told the Journal that when the price gap is about $0.30 apart, older arabica beans offer a better value for coffee buyers than robusta beans. As coffee buyers demand and purchase more arabica coffee beans, market prices for these beans will tend to rise .

In 2011, arabica beans commanded an almost $2 premium over robusta beans. Fast forward to 2013, and the robusta beans now look overpriced. Part of the reason for this is that Typhoon Haiyan in the Philippines delayed the harvest of top-exporter Vietnam's robusta crop. Some growers have also held onto their supplies and waited for prices to rise.

If coffee bean prices do head higher in the next few months, consumers shouldn't expect to pay higher prices right away. At Starbucks (NASDAQ:SBUX), the price of beans makes up a small amount of the total price customers pay. Historically, the price of coffee makes up about 8%-10% of the company's operating expenses .

Starbucks coffee -- a premium product with a premium price
In its 2012 annual report, Starbucks noted that it only buys arabica beans through fixed price contracts and price-to-be-fixed contracts. The price-to-be-fixed contracts have certain terms that are negotiated except for the delivery date and commodity price, which are set at a future point in time. Starbucks has the option to "fix" the price before the coffee beans are delivered, which it does through futures contracts . Losses from these contracts recognized in fiscal 2012 earnings were $3.4 million .

Total green coffee purchase commitments for fiscal 2012 were $854 million. Fixed price contracts totaled $557 million, and price-to-be-fixed contracts were estimated at $297 million . Starbucks' customers, as well as other coffee drinkers on average, are not as sensitive to the price of coffee as they are to other commodities like gas. This makes it easier for premium roasters like Starbucks to maintain high prices.

Dunkin' Donuts -- over 1 million cups of coffee served annually
Like its rival Starbucks, Dunkin' Donuts, owned by Dunkin' Brands Group (NASDAQ:DNKN), uses only arabica coffee beans in its coffee drinks. Dunkin's franchise-based businesses use a cooperative run by franchisee members to purchase their coffee supplies. The cooperative lets franchisees buy larger quantities of coffee at lower prices and establishes consistent product quality across all Dunkin' Donuts restaurants .

Although Dunkin' Brands does not directly purchase coffee supplies for its franchisees, coffee prices still play a critical role in the company's ability to generate royalty revenue. Coffee drink sales make up a major chunk of royalties for Dunkin' Brands due to the company's change in strategy that places greater emphasis on selling coffee drinks than baked goods. In 2012, Dunkin' Donuts' U.S. segment royalty revenue grew 6.3%; the company's international segment, while much smaller, grew 6.5% .

Green Mountain Coffee Roasters' coffee expenses improve in 2013                                                                                 As with Starbucks, for Green Mountain Coffee Roasters (NASDAQ:GMCR) changing coffee prices directly impact its over 200 varieties of coffee. For fiscal 2013, Green Mountain Coffee had favorable green coffee costs that improved by 290 basis points. Fourth-quarter green coffee costs improved even more by 380 basis points . The company uses coffee futures to attempt to fix prices for three to four fiscal quarters prior to delivery .

For fiscal 2013, Green Mountain Coffee Roasters' coffee futures contracts had deferred losses of $6.6 million, reported on the balance sheet and with no current impact on earnings. The company reclassified $1.48 million of these losses to cost of sales, making up more than half of the total cost of sales for 2013 of $2.7 million. According to the company's 10-K report, an additional $3.5 million of losses on coffee futures will hit earnings in the next 12 months. All of these losses reflect decreasing coffee market prices .

My Foolish conclusion
Coffee traders I&M Smith predicted in their Dec. 19 report that current coffee crop volumes are meeting market demand. Robusta crop volumes are expected to increase through the first quarter of 2014, which could put downward pressure on coffee prices. This could mean more losses on coffee futures for some of these companies.

If coffee prices increase instead, Dunkin' Donuts franchisees, which target a more value-conscious consumer, could see decreased profits from higher coffee bean prices. For Green Mountain Coffee Roasters, as well as Starbucks, the purchase of coffee futures decreases the impact of coffee price volatility and helps to maintain more stable product prices when coffee bean prices are rising.

What's the Fool watching in 2014?
There’s a huge difference between a good stock, and a stock that can make you rich. The Motley Fool's chief investment officer has selected his No. 1 stock for 2014, and it’s one of those stocks that could make you rich. You can find out which stock it is in the special free report: "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.

Eileen Rojas has no position in any stocks mentioned. The Motley Fool recommends Green Mountain Coffee Roasters and Starbucks. The Motley Fool owns shares of Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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