Green Mountain Coffee Roasters Inc. (GMCR), Starbucks Corporation (SBUX): Falling Coffee Prices Will Lead to What?

Page 1 of 2

Starbucks Corporation (NASDAQ:SBUX)As I write this, the price of coffee, both Arabica and Robust, is trading at multi-year lows and 60% below the highs seen back in 2011.

The reason for this? Well, there are several. First off is oversupply, as record prices in the past few years have drawn farmers into coffee farming but long growing times and the yield, which lasts for about two years, have contributed to oversupply in the market. Global coffee crops usually cycle over two years of rising and then falling production as the crop, when planted, will yield for up to two years. Brazil is in line for another record crop this year of 55 million bags.

The other factor influencing prices is the failure of the free market, or government intervention, as the Brazilian government props up loss-making farmers with subsidies. In Brazil, coffee costs around $1.26 per pound to grow, and in Colombia it cost around $1.60. Right now, coffee can be sold for $1.20, but has dipped as low as $1.17, making it totally uneconomical for growers. However, Brazil’s government is supporting growers, and recently unveiled a $1.4 billion support package to help farmers who are not making enough from their crops – effectively maintaining oversupply in the market and keeping prices low.

The market is weak but the beneficiaries are obvious

One of the beneficiaries from a weak coffee market will of course be Starbucks Corporation (NASDAQ:SBUX), which recently hiked its prices by 1% across many of its stores around the world. A small brewed coffee will now cost on average $0.10 more in Starbucks Corporation (NASDAQ:SBUX), although this will benefit investors as the higher prices combined with lower input costs will equal more profits.

How much more? Well analysts put the total cost savings for Starbucks Corporation (NASDAQ:SBUX) at around 50%, or half of the $1.4 billion that the company paid for coffee during 2012. Assuming that the company makes as much in revenue during 2013 as it did during 2012, saving $700 million a year on lower coffee prices will drive the company’s gross margin higher by 5.2% from 26.8% during 2012 to 32% in 2013 -excluding the effect of higher prices on its coffees sold. Assuming everything else remains constant, the company should see a $0.09 per share EPS boost.

The benefits also extend to Keurig brewer and K-cup provider Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR), which has had its earnings for the next two years consistently revised higher recently as coffee prices fall and margins grow. Like Starbucks Corporation (NASDAQ:SBUX), the company has maintained the prices on its goods sold, so margins and profits are only rising.

Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR) has had its average earnings estimate for 2013 revised higher from $2.50 per share back in November/December 2012 up to $3 per share, or 20% higher as of this month. The company’s projected earnings for 2014 have also been revised higher from $3 per share at the end of last year to $3.50 back in May.

Page 1 of 2