Percolating Coffee Profits

By Aaron Levitt | June 23, 2011 AAA

In today's world of highly caffeinated energy drinks and sodas, people tend to forget about the original energy drink: coffee. Despite the prominence of Red Bull, java remains the number one way the world gets its morning jolt. And just like the rest of the commodity spectrum, growing global demand coupled with shrinking supplies is having a dramatic effect on prices. Overall, coffee prices have nearly doubled between May 2010 and May of this year. With more bad weather, supply concerns and rising emerging market demand on the way, coffee prices could shoot higher in the long term. For investors, that could spell opportunity. (To learn more about coffee and other soft commodities, check out Trading The Soft Commodity Markets.)

TUTORIAL: Commodities

Jumping For Java
Overall, the price of coffee has surged 80.6% since January 2001 and represents a bigger market than silver. About $37 billion worth of silver was consumed in 2010. Total coffee consumption was about $38 billion for the year and that market is getting bigger. Worldwide demand continues to grow as purchasing power increases across the developing world. The International Coffee Organization estimates that global coffee consumption rose 2.4% in 2010 to a record 134.0 million 60-kg bags. The industry group expects that trend to continue, despite the rising prices this year.

Analysts predict China's coffee consumption will grow at 15-20% annually, driving by students returning from abroad and a newly emerged Chinese international business traveler. Currently, Chinese citizens only drink an average of three cups a year, well below the world's average of 240. A similar story is happening in Latin America, where Brazil's rapidly increasing coffee demand is expected to grow by 5% this year. Meanwhile, as the developed economies begin to show some signs of economic recovery, consumers are more willing to splurge on small luxuries like a fancy latte. Coffee demand is expected to grow, albeit slight, throughout the United States and Europe.

With demand continuing to increase, supply shocks are having devastating effects. Poor weather has already caused global coffee stockpiles to hit their lowest levels since the 1960s. Severe droughts have curtailed production Africa and a persistent La Nina weather pattern has caused Colombian coffee production to decline by 19% from a year earlier. This inclement weather, including high humidity, has led to outbreaks of diseases and pests, which have had significant effects on production. It takes three to five years for a coffee plant to reach maturity. (To learn what affects this rising commodity, read The Impact Of Rising Coffee Prices.)

A Caffeinated Portfolio
With coffee demand set to outstrip supply throughout the 2012 growing season, investors may want to add to the sector now. Both the iPath DJ-UBS Coffee ETN (NYSE:JO) and iPath Pure Beta Coffee ETN (Nasdaq:CAFE) allow investors to bet directly on rising coffee prices. However, the recent strength of the dollar has helped push commodity prices downward and many stocks within the coffee sector have pricing power are able to pass on increased costs to consumers. Investors may want to give some of these stocks a go.

Starbucks (Nasdaq:SBUX) remains the king of the coffeehouses and operates in 50 countries with over 17,000 stores worldwide. While paring down its developed market operations, the company plans to more than triple its cafes in mainland China, from 450 to 1,500 by 2015. In addition, the company has partnered with rival Green Mountain Coffee Roasters (Nasdaq:GMCR) to offer its coffees for the popular Keurig machines. Overall, Starbucks represents a good blend of growth and value, with a forward P/E of 20 and dividend yield of 1.5%.

While "regular" coffee sales and production are dominated by a few firms such as Kraft (NYSE:KFT) and Nestle (OTCBB:NSRGY.PK), super premium roasts are handled by a small number of firms. Both Peet's Coffee & Tea (Nasdaq:PEET) and Caribou Coffee (Nasdaq:CBOU) own profitable coffee shop chains, 193 stores and over 500, respectively. Both also distribute premium packaged coffee through grocery stores and could be a crown-jewel in an acquisition. Peet's has already seen strong gains since March, boosted by speculation the chain could be a possible takeover target for Starbucks.

Finally, Sara Lee (NYSE:SLE) recently announced that it will spin off its coffee business and use its $2.13 billion in cash to grow expand through acquisitions. There is potential that Sara Lee could leapfrog into becoming the world's second largest seller of the beverage. (For more information about these coffee stocks, check out A Double Shot Of Profits For Coffee Stocks.)

The Bottom Line
With global demand rising and supplies still threatened by poor weather, coffee prices will continue to rise. For investors, this rise in prices could spell opportunities in the coffee sector and investors have a variety of ways to profit. Either by betting directly on coffee prices or via stocks such as Farmer Brothers (Nasdaq:FARM), investors can add a jolt to a portfolio. (To help you determine if these stocks are in line with your investment strategy, read How To Pick A Stock.)

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