Question: Is now a good time to invest in coffee-related stocks?

Bear's Response
On July 26, coffeehouse powerhouse Starbucks (Nasdaq:SBUX) announced third quarter results that disappointed investors. It cited slower traffic in the United States and even more challenging trends in Europe, where it said it would be closing a batch of underperforming and unprofitable stores.

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Despite the success of Starbucks and rival coffee chains in recent years, growth appears to be slowing down overall and is at risk of a more major pullback thanks to sovereign debt worries in Europe that could derail the entire global economy. Additionally, the vast majority of coffee is brewed at home, and this segment of the market is having its struggles. Add it all up, and there are a number of near-term risks to investing in the coffee industry right now.

Industry Overview
In a recent presentation by Starbucks rival Caribou Coffee (Nasdaq:CBOU), it provided estimates that total U.S. coffee market sales run around $48 billion annually. It also detailed that close to 60% of U.S. adults have a coffee at least once a day and 70% drink a cup at least once per week. The market has grown rapidly in the premium and specialty coffee area, which now makes up nearly 40% of the total market.

It also cited the growth of the Keurig's K-Cup technology that allows consumers to make a single cup of coffee and other drinks right at home. The Keurig brand is owned and operated by Green Mountain Coffee Roasters (Nasdaq:GMCR). The major coffee chains have piled into the premium space and have announced their own K-Cup blends, but are seeing growth slow due to economic growth concerns and too much competition in the at-home market.

SEE: The Real Cost Of Drinking Coffee

Slowing Trends at the Coffee House
As Starbucks indicated in its quarterly report, global economic growth concerns are slowing consumer demand for their daily cup of coffee. In addition, as it indicated back in 2008 during the Great Recession, demand for coffee is more cyclical than previously thought. It was originally thought that workers would be unwilling to forgo a $4 cup of coffee or more expensive cappuccino or specialty drink in a large size, but the severe downturn caused Starbucks to close a large number of underperforming stores and undergo a rather major restructuring.

Overall, consumer sentiment is weakening in the U.S. and other developed markets such as Europe. A recent Wall Street Journal article cited slower restaurant industry traffic in June that continued into July. This doesn't bode well for the near-term prospects of Starbucks, Caribou, Dunkin Brands (Nasdaq:DNKN) and Peet's Coffee (Nasdaq:PEET).

K-Cup battles
Growth in the at-home market has been rapid in recent years, but the outlook is very uncertain. Keurig has revolutionized the market with its innovative and easy-to-use K-Cup technology, but is about to lose patent protection on these K-cups.

Starbucks has already announced plans to roll out a competing at-home product, and the market is already crowded with other competitors including Tassimo and coffeemakers from just about every other major industry player. This competition should benefit consumes in the form of lower prices and a wider selection of products, but will make it very difficult for investors to identify a winning firm to profit from.

SEE: Commodities: Coffee

The Bottom Line
Given all the near-term uncertainty for coffee demand at the major coffeehouses in the U.S. and developed world, it may make sense for investors to stay on the sidelines and wait for signs that the global economy might avoid another recession. Besides, the vast majority of coffee is brewed at home, and this market looks equally uncompelling for the time being. The K-cup battle will likely go on for many years, and makes this segment of the market even less appealing than the out-of-home marketplace.

Ryan C. Fuhrmann owns shares of Starbucks since 2001.

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Tickers in this Article: SBUX, GMCR, CBOU, PEET, DNKN

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