Why Does Starbucks Like Rising Coffee Prices?

It's official, coffee prices are on the rise. And unlike Dunkin', Starbucks is poised to benefit from the increase just like it did in 2011.

May 5, 2014 at 6:30AM

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.

Coffee

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.

Starbucks

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.

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B Bryant has no position in any stocks mentioned. The Motley Fool recommends 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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