Starbucks Corp. did very well as the price of coffee slid to seven-year lows in 2013. Will the coffee retailer do okay as coffee prices rebound?
On Tuesday, Arabica coffee futures rose as much as 10 per cent for their biggest one-day gain in more than nine years. They rose another 3 per cent on Wednesday.
The latest surge followed news of poor growing conditions in Brazil, the world's largest coffee producer, but the rebound has been going for about three months. Since November, coffee futures have bounced 57 per cent and are now sitting at their highest levels in more than a year.
That's good news for anyone who has invested in coffee: The iPath Dow Jones-UBS Coffee Subindex exchange-traded note (ticker symbol: JO), which tracks coffee futures, has risen 59 per cent from its low and jumped 6.5 per cent on Wednesday alone.
For coffee retailers, though, one key input cost is now heading in the wrong direction. According to Bloomberg Businessweek, Starbucks buys more than 3 per cent of the world's supply of unroasted beans, or about 500 million pounds of arabica, to keep its 19,000 stores running.
It didn't cut beverage prices when coffee prices were declining in 2013, helping to boost operating earnings by 23 per cent last year, expand operating margins by 150 basis points (to 16.5 per cent) and lift the share price by 46 per cent.
Those gains could be threatened. As Starbucks pointed out in a regulatory filing that highlighted the risks to its operations: "Because of the significance of coffee beans to our operations, combined with our ability to only partially mitigate future price risk through purchasing practices and hedging activities, increases in the cost of high-quality arabica coffee beans could have an adverse impact on our profitability."
Starbucks' share price has moved in the opposite direction to coffee prices – retreating about 10 per cent since November, which is when coffee began its rebound.
For sure, there are other factors at work here: Starbucks has made a big foray into China, where there are persistent concerns about the health of the economy.
As well, the consensus view is that Starbucks customers are not terribly sensitive to price: Since they have been paying a premium since the company was founded, they aren't likely to turn elsewhere should Starbucks offset rising coffee prices with price increases of their own.
Still, if falling coffee prices gave Starbucks a nice tailwind, it is hard to see rising coffee prices as good news now.