Profiting From the Coffee Market

November 2013: $1.06 Per Pound Average for Arabica Coffee Beans

March 14, 2014: Approximately $2 Per Pound Average for Arabica Coffee Beans

Potential Companies Impacted: Keurig Green Mountain (NASDAQ: GMCR  ) and Dunkin' Donuts -- a subsidiary of Dunkin' Brands (NASDAQ: DNKN  )

Company Not Impacted: Starbucks (NASDAQ: SBUX  )

Source: greenmountaincoffee.com.

Mountain of green or red?
Keurig Green Mountain -- formerly known as Green Mountain Coffee Roasters -- stands to lose the most due to recent cost increases for Arabica coffee. K-Cups have much lower price points than cups of coffee served at either Starbucks or Dunkin' Donuts. Therefore, Keurig Green Mountain doesn't have as much flexibility in regards to pricing, basically Keurig is more susceptible to margin contraction.

In 2013, low coffee costs allowed Keurig Green Mountain to enjoy a significant increase in net income of 26.82%. Now a drought in Brazil has led to increased costs for Arabica beans. Fortunately, Keurig Green Mountain has a price purchase commitment that locks in prices for approximately three months. But three months isn't that long, and if costs don't come back down, then net income could decline.

Also note that Keurig Green Mountain's top line has slowed considerably of late. Over a five-year time frame, revenue has increased 584.9%. However, over the past year, revenue has only grown 5.91%. Both Starbucks and Dunkin' Brands have grown their top lines faster than Keurig Green Mountain over the past year, with top-line growth of 9.38% and 6.92% respectively. Starbucks and Dunkin' Brands offer other advantages as well.

Locked-in
Starbucks' price purchase commitments are locked in for one year. Therefore, Starbucks doesn't have to worry about increased costs related to price hikes for Arabica coffee beans. This, in turn, means that Starbucks won't need to raise prices in order to maintain its margins. This then keeps customers happy and Starbucks customers have a reputation of being very happy with one of their favorite haunts.

As far as Dunkin' Donuts goes, its franchisees operate under a cooperative, which allows them to purchase large quantities of Arabica coffee beans at lower prices. However, the time frame for these cost savings is unknown. It's possible that Dunkin' Donuts will have to raise its prices in order to maintain its profitability.

Dunkin' Brands has seen a top-line improvement of 6.92% over the past year whereas its bottom-line has grown at a 38.38% clip. Therefore, Dunkin' Brands should be able to afford a slight hit to margins. And this is assuming that its price purchase agreements aren't locked in for a significant amount of time and the price of Arabica coffee beans remains high.

The good news for Dunkin' Brands is that it's seeing demand in its locations west of the Mississippi River, and it plans on expanding west in a big way, including a long-term plan of opening 1,000 locations in California. 

Another factor to consider is that Starbucks and Dunkin' Brands offer dividend yields of 1.40% and 1.80%, respectively, whereas Keurig Green Mountain offers a dividend yield of 0.90%.

On the other hand....
Though not the basis of this story, it's important to note that Starbucks and Keurig Green Mountain amended their five-year agreement, allowing Starbucks to offer more K-Cup choices, and leading to much greater volume opportunities for Keurig Green Mountain. The amended agreement should benefit both companies.

On top of that, Keurig Green Mountain recently formed a 10-year partnership with Coca-Cola. Coca-Cola is paying $1.25 billion for a 10% stake in Keurig Green Mountain and will help market the Keurig Cold at-home beverage system when it's ready. Due later this year or possibly next year, the Keurig Cola at-home beverage system is expected to dispense soda, enhanced waters, juice drinks, sports drinks, and teas -- covering the soda drinker, the athlete, and the health-conscious consumer.

When a growing company has partnerships with the likes of Starbucks and Coca-Cola, it's often a good sign for that company's long-term prospects.

The Foolish bottom line
Starbucks should be the least bothered by rising Arabica coffee bean prices thanks to its long-term price purchase commitments. Dunkin' Donuts might be affected in a small way, but geographical expansion should override any rising coffee costs due to its enormous potential.

Keurig Green Mountain might be hurt the most by rising coffee prices, which could have a negative impact on the company at some point over the next year. That said, Foolish investors see the big picture, and Keurig Green Mountain's partnerships with Starbucks and Coca-Cola give the company significant long-term growth potential.

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