With temperatures rising as summer officially starts, you’d think the last thing that one would want to think about is coffee. While it is the go-to perk-up for millions of sleepy commuters each day, there isn’t much call for a hot cup of joe when it’s 90 degrees outside. Nobody told the Brazilian Arabica growers that, though, and the influx of Brazilian java has made coffee the summer’s most intriguing commodity, a surprise to a lot of commodities traders and a neat little treat for coffee stock lovers thanks to low coffee prices. However, the low prices may give coffee stock investors a summer of love, but it may soon turn into a winter of discontent.
Surprise from the Coffee Growers of Brazil
This month, without much fanfare, Brazil was able to export 320 bags of Arabica coffee to the ICE exchange in New York, totaling 19.2 tons of beans, at a 900-point discount to the exchange price. This comes despite a downturn in the sale of coffee beans worldwide, with Arabica futures at a 4-year low price of $1.15/pound. Brazil’s huge export helped push the price down to this point, which is currently lower than the cost of production. Due to a falling real on the currency exchange, Brazil was able to export this huge shipment and still benefit, despite the small profits, as well as the fact that it is coming towards the end of the main Arabica harvest season, where prices should be on the increase due to the lower amounts of coffee beans being traded as a result.
Cheap Coffee Soon Ending?
This has caused the import and export of coffee, at the moment, to enter bear market in the commodities world, but this won’t last long. Brazil’s one-time dump will only temporarily suppress coffee prices. In addition, the low profitability of exporting coffee for farmers has led to a decline in care for the delicate Arabica trees, with farmers cutting back on fertilization and general tree maintenance. While a cost-saving measure now, this will hurt Brazilian yields in the future due to the lack of attention being paid to the plants. Also, a coffee-rust disease called roya has gripped the Central American crop, which accounts for nearly 10% of world coffee exports, and will lead to lower output from this region in the near future. According to some analysts, a combination of these two factors should push the coffee price to nearly $1.50/pound on the commodity exchange, or a near 33% price jump. This will help make a bull market for traders in coffee, and should keep coffee supplies under control.
So About that Morning Cup…
While that may be good news for coffee traders, it will be bad news for those that have investments in the two main coffee chains in America, Starbucks Corporation (NASDAQ:SBUX) and Dunkin Brands Group Inc (NASDAQ:DNKN). In the past year, coffee prices have plunged 30%, which has been a boon to these two companies because the low price of beans has helped increase operating margins due to the abundant supply of Arabica beans, and has contributed to a 20% share price increase for both companies over the same time frame. Starbucks Corporation (NASDAQ:SBUX)’s quarterly revenue grew by 11.3% year-over-year, while Dunkin’ grew by 6.2%.
In addition, Starbucks Corporation (NASDAQ:SBUX) quarterly operating income grew 10.79% to $544 million, while Dunkin Brands Group Inc (NASDAQ:DNKN)’s grew by 36.9% to $63 million for the last quarter. In addition to E/P ratios growing 2-3% over the past year, these two companies have taken advantage of the fall of coffee prices and have been able to rake in profits and investors. The recent influx of Brazilian coffee will keep these profits going for much of the summer, but the good times for these two won’t last long.
That Cappuccino Is Gonna Cost Ya
Starbucks Corporation (NASDAQ:SBUX) has already seemed to guard against a potential fall in profitability by increasing certain drink prices by 1% across most US outlets. While reasons weren’t directly given by the company, other than that it will be on premium drinks like lattes for the most part, it could be a safeguard against bad quarterly earnings this fall and winter due to the expected hike in coffee bean prices. A 1% increase would hardly be noticeable to the average Starbucks customer, who typically doesn’t mind paying a little extra for the benefit of artisan coffee in a very casual coffeehouse setting. Also, for those that do mind, there will still be alternatives that Starbucks Corporation (NASDAQ:SBUX) offers, like tea, hot chocolate, and their hot apple cider in the fall months that will keep Starbucks’ profit margins healthy.
Dunkin Brands Group Inc (NASDAQ:DNKN), meanwhile, operates a bit differently. There hasn’t been an announcement yet on a beverage price increase from them yet, though they may not have to. Dunkin’ relies on selling no-frills, no-nonsense coffee and donuts to those that are on the go, so there is less demand for the artisan coffees that Starbucks tends to excel in. Also, Dunkin Brands Group Inc (NASDAQ:DNKN)’ does a lucrative business with its K-Cups through Keurig and Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR) as well as selling bags of coffee beans in most supermarkets, so there is already built-in insurance against losses due to coffee price increases because they are more diverse in their product range than Starbucks is.
Another Bad Sign for Green Mountain
While not a coffeehouse chain, Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR) should also feel the pinch from higher coffee prices in the future. While the Green Mountain range goes far beyond coffee to include the wildly successful Keurig brewing system (of which Dunkin Brands Group Inc (NASDAQ:DNKN)’ is a contributor of K-Cups), any rise in coffee prices will still be felt by the company. Already, shares have plunged to near $73/share as the CEO is set to retire, and the potential increase in coffee prices will hit the company further. Sales for the quarter are already expected to be on the low side, with an expected July put of $77.50. However, Green Mountain has been a big moneymaker for a lot of people since the boom of Keurig, and it should weather the storm, though it is a bear at the moment thanks to a CEO shakeup and the rise of coffee prices taking a hit on the costs of making and selling K-Cups.
Last Few Swigs
If you have either Starbucks or Dunkin’ in your portfolio, it may be wise to hold on to these two companies through the summer, but don’t go buying anymore stock because the ride may soon be over. The coffee prices on the commodity exchange will tell the story of where these two companies will go. Once the price of coffee hits $1.30/pound on that exchange, it will be the time to cash in on the gains for these companies, because both will take a hit from the price hike to come. Neither will see a major downturn, though any chance of a repeat of this past year will probably be slim, because these two giants mirror the commodity exchanges very closely.
Hope you enjoyed that hot cup of profit, now it’s time to make sure you don’t get a caffeine headache.
John McKenna has no position in any stocks mentioned. The Motley Fool recommends Starbucks. The Motley Fool owns shares of Starbucks.
The article Prepare for the End of the Coffeehouse Boom originally appeared on Fool.com and is written by John McKenna.
John is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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