Investing

The Stock Market's Coffee Craze


Despite a recession, these are hot times in the stock market for the coffee business. Shares of Green Mountain Coffee (GMCR), which reported impressive earnings July 29, are up 169% in 2009. One small coffee wholesaler, Diedrich Coffee (DDRX), is up 6,650% this year.

Even beleaguered coffee chains are bouncing back from steep declines in previous years. Starbucks (SBUX) shares have risen 87% in 2009, while second-place rival Caribou (CBOU) has seen shares quadruple in value (up 311%).

It's not that coffee drinkers haven't cut back somewhat on their daily caffeine fix—at least outside the home. Last quarter, Starbucks' same-store sales were 5% lower than the year before.

Changing the Business But the coffee business has been surprisingly resilient in the face of the steep economic slowdown. At the same time, powerful trends—new technology, changing tastes, and new industry players—have made many coffee stocks powerful investments.

Green Mountain Coffee got investors' attention with the success of its Keurig coffee brewers. Costing about $100 each, these brewers make single cups of coffee at home in about 30 seconds. "Every 10 or 15 years something comes around that changes the way people drink coffee," says Scott Van Winkle, an analyst at Canaccord Adams. Easy to use and easy to clean up, "this is the new thing in coffee brewing," he says, noting sales of the brewers were up 187% last quarter.

On July 29, Green Mountain beat Wall Street expectations with earnings of 36¢ per share. Green Mountain doesn't just make money off the Keurig units, but also the small packs of coffee, called K-Cups, that the brewers use. Green Mountain makes its own K-Cups, but it also licenses that privilege to companies like Diedrich Coffee. In June, Diedrich announced it was boosting its output of K-Cups by 40%.

"An Affordable Luxury" Though not profitable on an annual basis since 2005, Diedrich, with a market value of just $127 million, posted a small profit last quarter. The result: Diedrich's share price has risen from 23¢ last November to 23.15 on July 30.

The growing popularity of at-home, single-cup brewing fits with trends coffee experts have seen since the economy began slowing down. "Coffee in general is doing well. It's proven to be pretty recession-resistant," says Ric Rhinehart, executive director of the Specialty Coffee Association of America, which counts as members more than 2,000 businesses up and down the U.S. coffee supply chain.

"As people cut back, coffee is an affordable luxury," says Michelle Rhodes-Brown of Profit Investment Management, which owns Green Mountain shares.

Drinking More at Home But, while Americans are still drinking plenty of coffee, they're getting coffee from different places. Purchases of coffee for the home are up, while sales at coffee shops and other retail locations have softened, Rhinehart says.

Though the recession has hurt some coffee sales, it hasn't ended Americans' move toward higher-quality coffee, says Bruce Milletto, president of Bellissimo Coffee InfoGroup, which provides consulting and training to the industry. "Our taste buds have memories," Milletto says. "Once you drink a really excellent cappuccino, it's very hard to go back even to a chain store that may be using automatic machines."

Despite the recession, "consumers are becoming more particular," he says. "We want good coffee and we're willing to pay for it."

McDonald's May Be Helping One sign that specialty coffee is still on the rise is that it's been embraced by mass-market chains like McDonald's (MCD) and Dunkin' Donuts. Both have upgraded their coffee offerings in an attempt to steal business from Starbucks.

But instead of seriously hurting Starbucks' business, the marketing push from McDonalds this year may have actually sparked more interest in coffee in general. That's what Starbucks Chief Executive Howard Schultz said in July, telling analysts: "It appears that the various marketing campaigns and all the media coverage of our coffee has created unprecedented awareness for the coffee category overall."

Peet's Coffee & Tea (PEET) is a company that prides itself on the very highest-quality coffee, sold both through supermarkets and its own coffee shops. On July 28, Peet's announced quarterly earnings per share 24% higher than a year ago. Despite the tough economy, revenue rose 5% from a year ago.

Can It Last? Grocery store sales were also up 10% and Peet's market share was up 10%—showing customers were willing to pay more for quality coffee at home. "Peet's may very well be one of the few premium-priced brands in the grocery store achieving strong sales and share growth despite the economic and competitive environment," Peet's President and CEO Patrick O'Dea told analysts. Peet's shares are up 17% this year.

Perhaps investors shouldn't have been surprised that coffee would hold its own during the downturn. Coffee is relatively inexpensive, particularly when prepared at home, Van Winkle notes. Also, he adds, "we are talking about an addictive product."

The question for investors now is whether the coffee craze can continue. Many coffee stocks have gotten rather expensive. Green Mountain shares trade at more than 60 times 2009 earnings. Companies like Caribou and Starbucks are in the midst of turnarounds that are still in early stages. At the beginning of 2009, Caribou reported its first quarterly profit since 2005.

Some coffee stocks may have further to run, though only if current growth trends continue and even accelerate. With coffee shares at these heights, investors need to be especially alert to signs the country's love of coffee has run its course.
Steverman is a reporter for Bloomberg News in New York.

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