Investing

Takeover Roasts a Hot Market for Coffee Stocks


Two small companies joining forces might not normally attract much notice. But the Nov. 3 acquisition of Diedrich Coffee (DDRX) by Peet's Coffee & Tea (PEET) combines two especially hot stocks at a time when the coffee industry is an investor favorite. The $213-million buyout of Diedrich caps an extraordinary stock market run. The Irvine, Calif., company's shares traded at 36¢ at the start of 2009 and have rocketed more than 70 times higher, ending with Peet's cash-and-stock offer of $26 per share. Peet's, based in Emeryville, Calif., has had a good run, too, up 65% this year. On Nov. 3, the stock market cheered Peet's unexpected acquisition of Diedrich, pushing Peet's shares up 11% to 38.44, and Diedrich's stock nearly 27% higher, to 25.83. Indeed, coffee stocks have perked up strongly this year. Despite a recession that hurt coffee shop sales figures, shares of Starbucks (SBUX) have doubled in 2009, and rival Caribou (CBOU) is up 558% this year. One reason for this performance is that investors have rushed back into the stocks after dumping them in 2008 amid worries that the recession would pressure coffee industry sales, Instead says Ric Rhinehart, executive director of the Specialty Coffee Association of America, coffee consumption has actually seen a slight uptick. Maybe it's the addiction to caffeine. "Coffee drinkers are loathe to stop drinking coffee," Rhinehart says. McDonalds whetted consumer appetitesAnother powerful trend has boosted coffee shares—the increasing sophistication of American coffee drinkers. "[There] is really a trade-up to the higher-quality specialty or gourmet coffee blends—and away from more mainstream blends," says Robert W. Baird analyst David Tarantino. And because just a fraction of American coffee drinkers pay more for fancier java, "it's a trend that can continue," he says. Jumping on that trend have been McDonalds (MCD) and Dunkin' Donuts, which have upgraded the quality of their coffee. That was ostensibly a way to compete with such chains as Caribou and Starbucks, but Rhinehart—echoing comments by Starbucks Chief Executive Howard Schultz and others—believes the improvement actually made specialty coffee more popular. Rather than hurting Starbucks or others, "they created new consumers," Rhinehart says. Society's turn toward specialty coffee has certainly helped Peet's, which calls itself "the premier specialty coffee and tea company in the United States." With its products distributed through its own coffee shops and delivered fresh directly to grocery stores, Peet's sales have almost doubled in the past four years. The acquisition of Diedrich gives Peet's access to another, growing niche market. Diedrich specializes in making so-called K-cups, small packs of coffee designed for brewing coffee a cup at a time. Green Mountain Coffee (GMCR) makes Keurig coffee brewers, designed for the workplace or home and costing about $100. The company's brewer sales jumped 187% in the last quarter. Spreading single-serve coffee systemsSingle-cup brewers satisfy consumers' desire for convenient, high-quality coffee. Popular with early adopters, "it doesn't feel like a fad," Tarantino says. Green Mountain shares, by the way, have shot up 166% this year. Supporters of the Diedrich acquisition argue that the popularity of Peet's brands—which now include Godiva—and its ability to distribute products could boost the popularity of single-cup brewing. "The combined company will accelerate the adoption of the K-Cup single-serve system," Diedrich Coffee Chairman Paul Heeschen told analysts on Nov. 3. Analysts warned that the deal requires $140 million in debt and could hurt 2010 earnings. But executives said earnings-per-share could double by 2011. "This combination of Peet's and Diedrich is a significant win for everybody," Peet's chief executive Patrick O'Dea told analysts. One impact of the recession has been a move toward drinking more coffee at home or at workmdash;where it is generally cheaper—and less of it at restaurants and coffee shops. But even that trend seems to have softened in recent months, Rhinehart says. He believes the popularity of coffee shops such as Starbucks has survived the recession. "People are returning to the coffee house because it is a place where they're comfortable and a place they get benefits other than coffee," Rhinehart says. Earnings releases from Caribou on the evening of Nov. 4, followed by Starbucks on Nov. 5, should give further clues as to whether Americans' appetite for coffee is waning. The proposed merger of Peet's and Diedrich thus adds attention to an industry that has been a stock market star for months. The biggest danger may now be that the realities of the coffee business could fail to live up to investors' high hopes.
Steverman is a reporter for Bloomberg News in New York.

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