Bull Vs. Bear: Why The Coffee Business Is A Buy

By Will Ashworth | July 31, 2012 AAA
Question: Is now a good time to invest in coffee-related stocks?

Bull's Response
It's been a smoking hot summer. AccuWeather says last summer was the hottest since 1936 and this summer could be even hotter. Coffee lovers in the Midwest and most other parts of the country are having less warm drinks and more iced lattes. What that means for coffee stocks is hard to say. For every bad piece of news that comes out about the coffee business, there's a snippet of good news. I for one have a glass that's half-full and believe now's a good time to make a coffee investment. Here's why.

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Coffee Icon Acquired
Speculation is rampant why Germany's Reimann family is acquiring Peet's Coffee & Tea (Nasdaq:PEET) for almost $1 billion. Bart Becht, Chairman of Joh. A. Benckiser, the Reimann's personal investment company, suggests JAB is "committed to owning and investing in companies with strong, premier-quality brands..."

Becht, who also happens to be the former CEO of Reckitt Benckiser, was probably eager to do something big after JAB's Coty subsidiary pulled out of its $10.7 billion takeover of Avon Products (NYSE:AVP) in May. My personal feeling is that JAB is interested in growing the brand's packaged goods business and not the retail side of things. With only 196 stores in America and margins not nearly as strong as the grocery store business, it makes sense to sell the retail to someone who can use those locations. Whatever the motivation, the Reimann's feel Peet's enterprise value is worth almost 21 times EBITDA. If that doesn't suggest the coffee business is still attractive, nothing does.

SEE: A Clear Look At EBITDA

Stores to Double
Earlier in the year Dunkin Brands Group (Nasdaq:DNKN) announced its Dunkin Donuts brand was doubling the number of stores in the U.S. from 7,000 today to over 14,000 by 2032. According to market research firm IBISWorld, Americans, on average, consume seven pounds of coffee per person each year. It's this kind of number that has Dunkin reaching beyond its New England stranglehold. Trailing Starbucks (Nasdaq:SBUX) by almost 10% market share (23% to 32.6%), it obviously feels like there's plenty of business to go around. I would have to agree.

Fourth Quarter
The expectations are so high for Starbucks that its stock dropped almost 10% this past Friday, its biggest decline since August 18 of last year. The reason for the slide on a day when the Nasdaq was up 2.24%? It guided fourth quarter earnings down two cents to 45 cents, three cents worse than analyst estimates. CFO Troy Alstead believes the consumer is very concerned about the economy and spending accordingly. In addition, Starbucks is taking it on the chin in Europe and that could continue for a very long time.

Nonetheless, business is still good. Third quarter same-store sales grew 6% globally and 7% in the Americas, with net income up 19% to 43 cents a share. There are going to be bumps in the road but this points out just how strong the coffee business really is. Starbucks, which in my estimation is a better company than Peet's, has a current enterprise value that's 15.4 times EBITDA, 25% less than Peet's valuation.

SEE: Equity Valuation In Good Times And Bad

Trading Down
Some believe that weakness at Starbucks is an indication that coffee lovers are trading down to brands like Dunkin, Caribou Coffee (Nasdaq:CBOU) and Tim Hortons (NYSE:THI). As mentioned earlier, there's plenty of business to go around. Tim Hortons' 721 U.S. locations achieved Q1 same-store sales of 8.5% against strong numbers the year before.

Growing its U.S. store count by 27% in the last two fiscal years, the 196 Peet's locations, which are primarily in the western half of the country, would definitely come in handy. As for Caribou, it recently hired Leigh Anne Snider as its Senior VP of Retail Operations. Most recently, Snider was COO for the Long John Silver and A&W Brands until Yum! Brands (NYSE:YUM) sold the two chains in late 2011. Snider brings years of experience to a chain with almost 500 company-owned locations. To get over the hump, it's going to need more top-notch talent. Snider signing on is a sign that coffee's still got some kick.

SEE: Trading The Soft Commodity Markets


Coffee Prices
In the second quarter, they dropped 6.8% on concerns of weak consumer demand. While Brazil is in the midst of a bumper crop, a heat wave gripping most of North America has demand relatively benign. Coffee consumption since 2000 has increased by 2.5% annually. In 2011, that dropped 80 basis points to 1.7% as consumers in places like the U.K. drastically curtailed their coffee intake. As long as coffee consumption continues to grow and coffee prices stay moderate, publicly traded coffee businesses have an opportunity to grow more profitably. If demand were to overheat, profit margins would be immediately tested. The conditions at present, assuming the global economy gets no worse, are actually quite favorable.

SEE: The Real Cost Of Drinking Coffee

The Bottom Line
Coffee's getting a bad rap these days because Green Mountain Coffee Roasters' (Nasdaq:GMCR) stock has fallen off a cliff. Down 51% year-to-date thanks to a number of gaffes, including working a deal with Starbucks when they had to know it was going to develop its own machine and pod design was simply short sighted. The coffee business is a good one and if Green Mountain can stop shooting itself in the foot, it too has a reasonably solid future.

At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.

Don't forget to read the Bear Side of this debate and weigh in with your opinion below.

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