Coffee commodity prices have continued to drop over the past week. The trend may have implications for Aussie hospitality investments.
Coffee prices continued to fall this week, down 8% from a high of 146.89c per pound down to 135.67c this morning. This bucks the trend set by other ‘breakfast commodities’ such as cocoa, sugar, butter, and orange juice.
These low ‘C-market’ (commodity coffee) prices could have a positive impact on the profits of some food businesses in Australia. Unfortunately, it probably doesn’t mean that your morning latte is going to get any cheaper. But it could mean bigger profits for some food businesses in Australia.
Why a cuppa at your local café hasn’t got cheaper
You may look at the coffee price drop and wonder, ‘why am I still paying $5 for a cup of coffee from my favourite café?’
The answer is more complicated than you might think.
First, many small cafés now serve specialty coffee. This is coffee that gets a high score – at least 80/100 – on a Q grading scale. This scale is an international standard defined by the Specialty Coffee Association of America. To put things in perspective, only roughly 5–10% of all coffee produced meets this standard.
Specialty coffee is not traded like a commodity. It is not traded on the open market. Often, roasters will deal directly with farmers. This is called direct trade.
Sometimes, co-ops will deal with importers, who in turn deal with local roasters. They often pay much more than the C-market price. The link between C-market prices and specialty prices is very loose. Commodity coffee would have to go up a lot to affect specialty coffee.
Second, many large chain shops use coffee that is not freshly roasted. Like the beans you buy at the supermarket, chances are they were roasted up to six months ago — maybe in Italy — then shipped here. The green (unroasted) beans may have been purchased months before that. Perhaps they were bought as futures contracts, when the price was even higher.
What this means for Aussie food retail stocks
There’s an obvious link between coffee prices and the profit potential of some coffee retailers. Since October, Starbucks [NASDAQ:SBUX] share prices have risen as coffee prices have dropped. This is because coffee is one of the main inputs affecting its profitability.
These businesses, and in turn their parent company, may benefit from coffee price trends like Starbucks has. Another good sign for profits is that the latest ABS stats show that spending in cafés rose 0.5% in February. This should mean that any boost from lower coffee prices won’t be offset by low spending.
But it’s not all good news. The downward trend in coffee prices is likely due to a supply glut — one that may not last long. The latest International Coffee Organization reports say production (supply) is down in many major coffee producing countries. This means prices are likely to rise in the near future, and that means profit margins may fall back down again.
There’s more than one way to make money from Australia’s coffee addiction though. Some private equity firms invest in coffee roasters with very distinctive brands such as Stumptown or Dôme. Stumptown Coffee Roasters, a big US specialty coffee brand, is part owned by private equity fund TSG Consumer Partners. In Australia, Navis Capital Partners has invested in Dôme Coffees, a big Euro-style chain based in WA. Investing in a roaster can be profitable because roasting adds a lot of the value. The price difference between a kilo of green beans and a kilo of roasted beans can be huge — up to 400%.
Contributor, Money Morning