Why Higher Coffee Prices Are a Blessing in Disguise for Starbucks and Dunkin’ Donuts

The results could mean more profits.

Jul 6, 2014 at 10:00AM

Images
Source:  Starbucks

It sounds counter-intuitive at first. How could Starbucks (NASDAQ:SBUX) and Dunkin' Donuts (NASDAQ:DNKN), both of which realize the majority of their sales and profits from coffee, actually benefit from higher coffee costs? In addition to the obvious answers, less-obvious answers exist that most people overlook.

The more-obvious reasons why these costs won't hurt
First, coffee chains like Dunkin' Donuts and Starbucks can adjust their own prices based on inflation and pass the extra costs onto consumers. For example, on June 10, Dunkin' Donuts stated that it expects "modest increases in coffee prices" in reaction to a spike in the cost of the beans.

This comes after a 90% rally in global coffee prices between January and April of this year due to drought concerns in Brazil that made growing the crop more challenging. Packaged coffee distributors that sell Dunkin' Donuts coffee in stores responded earlier in June by increasing their prices by 9%.

Slide

Source: Dunkin' Brands Group

Second, in order to make their costs more predictable, Starbucks and Dunkin' Donuts engaged in complex hedging contracts which essentially bet that coffee prices would rise. As a result the profits generated from the "bets" offset the cost increases and locked in specific contracted prices. This is similar to what the airline industry does with fuel.

Third, the beans themselves barely cost any money in the first place relative to the price that these companies receive for coffee. For Starbucks, the cost is less than $0.10 on the dollar or a 900% markup. You know how cheap it is to brew an entire pot at home -- a fraction of the cost of one cup at Starbucks and Dunkin' Donuts -- so you could probably only imagine how cheap it is for those guys. And they don't pay retail like we do.

A less-obvious reason
The less-obvious reasons are simply mathematics and economics. Even the mom and pop coffee chains that don't engage in complex coffee bean cost hedging could benefit. First part is the simple fact that coffee on the retail level is extremely inelastic in part because it's so cheap in the first place in the big scheme of things.

Few of us will skip out on a much-needed $1 to $2 cup of Joe from Starbucks or Dunkin' Donuts in order to save money in the first place. (Yes, plain ole regular coffee is still within that cheap range). We're probably not going to pop into either one, see that the price has gone from $1 to $1.20 or from $2 to $2.40 and say, "That's too much, I'm out of here!"

As an example, at one point in Starbucks history the company raised the price of mocha by $0.25 and regular coffee by $0.10. The Sacramento Bee reported on the response to the price hikes "...in testament to Starbucks' mastery of the gourmet coffee scene, customers barely flinched, the espresso machines kept s-s-sissing..." You'll have to pry my cup from my latte-warmed dead fingers as well.

Images

Source: Starbucks

Even less obvious, perhaps...
Remember that I mentioned that Dunkin' Donuts and Starbucks are hedged and protected from coffee price increases? Yeah, but that doesn't stop them from passing the "cost" onto consumers anyway. A cost that doesn't exist. Which means more money in both companies' coffers.

What's worse for consumers is that often the headlines just act as the perfect excuse for Dunkin' Donuts and Starbucks to raise prices -- permanently. For example, Starbucks raised prices in 2013 by an average of 1%. During much of the same year, actual coffee bean prices got crushed by as much as 29%. Did Dunkin' Donuts and Starbucks respond by lowering their prices? Of course not.

The takeaway here is not to fear global coffee prices when you analyze the fundamentals of your favorite coffee and pastry chains. If anything, cheer for rising costs.

Leaked: This coming device has every company salivating
The best investors consistently reap gigantic profits by recognizing true potential earlier and more accurately than anyone else. Let me cut right to the chase. There is a product in development that will revolutionize not just how we buy goods, but potentially how we interact with the companies we love on a daily basis. Analysts are already licking their chops at the sales potential. In order to outsmart Wall Street and realize multi-bagger returns, you will need The Motley Fool's new free report on the dream-team responsible for this game-changing blockbuster. CLICK HERE NOW.

Nickey Friedman 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.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at www.fool.com/podcasts.

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to www.fool.com/podcasts, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.

 


Compare Brokers