Why Does Starbucks Like Rising Coffee Prices?

2013 was a rough year for Dunkin' Brands (NASDAQ: DNKN  ) . Same-store sales growth stalled in every segment. On the first-quarter earnings call, CEO Nigel Travis reported another poor quarter but reminded investors about the volatile weather that had a strong effect on peak morning business.

When our guests' normal morning routine gets disrupted by store closings as a result of snow and bad storms, we lose their visit on that particular day. That visit, in most cases, is not recoverable.

Then on April 24 Starbucks (NASDAQ: SBUX  ) made Travis look stupid by reporting record financial results for the quarter ended March 30. Global same-store sales were up 6%, net sales increased 9%, and operating income rose 18%. By all accounts the trend was positive, despite Starbucks having to deal with the same headwinds as Dunkin'. If you believe most headlines, however, that trend is about to change due to the rising price of coffee. Don't be fooled. Historically, an increase in the price of coffee has benefited same-store sales growth for Starbucks, just like it did last quarter.

Historical coffee prices
At year-end 2010 coffee futures were at the same level they are at today; the trend is up due to Brazil's drought. Volcafe cut its forecast for coffee supply by 11% due to the drought, but the full impact won't be known until the end of May.

As you can see from the chart below, a similar increase in coffee prices began in mid-2010 and ended in mid-2011. The question for major sellers of coffee products is whether or not they're prepared to weather the upcoming price storm if the drought continues.

Source: Nasdaq 

According to The Wall Street Journal, Craig Russell, Starbucks' head of coffee, has already purchased 40% of next year's supply needs. Dunkin' has prices locked in through the end of this fiscal year but may decide to make purchases in the fourth quarter. "Eventually, you have to buy coffee," said Russell. It is this eventuality that is Starbucks' secret weapon, and opportunity, against competitors.

High coffee prices present an opportunity for Starbucks
As Russell said, at some point coffeehouses will have to buy more coffee.

These may be smaller stores or independent coffee shops that don't sell enough coffee to make forward purchases of the commodity at locked-in prices like Starbucks and Dunkin'.

As a result, these smaller coffeehouses are forced to either eat the costs or pass them on to customers. By around the third price increase, even the most loyal customers begin migrating to Starbucks; it feels more like an independent coffeehouse than Dunkin Donuts does, but the prices are affordable. It's a survival-of-the-fittest customer-acquisition strategy that fuels growth for Starbucks in times of rising coffee prices. Indeed, Starbucks' same-store sales peaked in 2011, and earnings per share grew more than 100% from 2009 to 2011.

Takeaway
People go to Starbucks for more than the insanely addictive commodity it sells -- there's something about the place that makes you feel like you're "cool." Maybe it's the music or the heavy conservationism theme that permeates the stores; perhaps it's the hip, multicultural baristas who write your name on every cup. It has all the feel and charm of a cozy coffee shop; and when one independent coffeehouse is closed, there's usually a Starbucks around the corner.

In all appearances, there's no difference between Starbucks and the independent coffeehouse, but Starbucks is really a large, multinational conglomerate with a slick business model that thrives when coffee prices rise. Look for increases, not decreases, in same-store sales growth over the next year, as increases in coffee prices tend to add value to this company.

Your credit card may soon be completely worthless
The plastic in your wallet is about to go the way of the typewriter, the VCR, and the 8-track tape player. When it does, a handful of investors could stand to get very rich. You can join them -- but you must act now. An eye-opening new presentation reveals the full story on why your credit card is about to be worthless -- and highlights one little-known company sitting at the epicenter of an earth-shaking movement that could hand early investors the kind of profits we haven't seen since the dot-com days. Click here to watch this stunning video.


Read/Post Comments (0) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2934445, ~/Articles/ArticleHandler.aspx, 10/1/2014 1:05:51 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement