Strong Coffee Crop To Have Limited Effects On Starbucks' Margins

We expect strong Brazilian coffee production in 2013/14 despite it being an off-year for the crop and in spite of the fact that domestic exporters have suggested that the country will have fewer coffee exports in 2012. As of early December, coffee crop flowering appears to be largely on schedule due to good weather conditions, meaning that next year's off-year crop will still be one of the largest on record. Despite this, we continue to forecast higher average coffee prices in 2013 than current levels. This is not expected to have a significant effect on key coffee makers such as Starbucks, whose share price and margins have largely not reflected the effects of coffee prices in recent years.

We continue to forecast a very strong off-year Brazilian coffee crop in 2013/14 at around 54mn tonnes despite weaker exports in the 2012 calendar year. According to domestic exporters, the country will ship roughly 5mn fewer bags (10% of the total crop) in the 2012 calendar year than 2011 despite the fact that the country was in the up-year of its biennial cycle and harvested a record 51mn bags. Exports have been lagging 2011 totals for most of the year, largely because of delays to the harvest and lower prices. In particular, heavy rains in the middle of the year slowed the harvest considerably, while port delays increased.

Lower Than Last Year
Brazil - Arabica Coffee Monthly Exports ('000 bags)

Furthermore, coffee prices have been one of the worst performing commodities in the entire commodities universe in 2012. This has prompted speculation of hoarding as farmers hold out for higher prices. Even with the delays, we continue to forecast a very strong season in 2013/14, as the flowering process has so far been supportive. We continue to forecast output of 46mn bags in 2013/14, one of the highest off-year totals ever. We are below consensus estimates for now, which project off-year production reaching 51mn bags for 2013/14, largely due to our expectation for that weather concerns may be a factor during next season.

Even with the increase in Brazilian production, which is sparking talk of a glut in global arabica supplies, we continue to forecast higher average coffee prices in 2013 than spot prices (of around USc140/lb for the December contract). This is mainly predicated on our view that prices will hold technical support for at least the next few months, combined with downgrades to Colombian production from 9.0mn to 8.5mn bags for the 2012/13 season and our expectation for weaker supply growth from Vietnam, the world's second largest exporter.

Correlation Breaking Down
US - Front-Month ICE Coffee (USc/lb) & Starbucks Share Price (US$)

For key coffee makers such as Starbucks, the increased supplies are likely to help improve margins, although we believe that the impact could be relatively muted. Starbucks has suggested that coffee prices could have an adverse impact on profits given that it is a key input and because the company can only partially mitigate price risk through effective purchasing, hedging and selling costs. However, Starbucks already has relatively high margins, and the statistical correlation between the company's share price and benchmark coffee prices has broken down in recent years.

Still Stable
Starbucks - Gross Margins (%)

In addition, a look at the company's gross margins suggest that they have been relatively stable in recent years. For example, the standard deviation in Starbucks' quarterly gross margins since Q104 has only been around 1.58%, despite the fact that coffee prices tripled between 2009 and 2011 (nearly setting all-time highs) and have fallen by 50% since then. Indeed, gross margins for Starbucks actually increased every quarter but one between Q109 and Q211, a span of 10 quarters. All of this suggests that factors other than coffee prices will be greater determinants of Starbucks' profitability.

Brazil Coffee Production & Consumption , 2012-2017

2012 2013 2014 2015 2016 2017
Coffee Production, '000 60kg bags 1 43,551.2 51,000.0 e 46,000.0 f 52,000.0 f 46,500.0 f 54,000.0 f
Coffee Consumption, '000 60kg bags 2 20,015.4 f 20,515.8 f 21,028.7 f 21,449.2 f 21,878.2 f 22,315.8 f
This article is tagged to:
Sector: Food & Drink, Agribusiness
Geography: Brazil

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