How Coffee Prices Affect the Profit in a Cup

When investors trade on the commodities exchange, they largely deal with fungible goods. A bale of cotton from Farm A is replaceable with a bale from Farm B. In most cases, consumers treat coffee like this, and on the commodities market, investors trade it as if it were fungible. That doesn't mean that it always is, though, and while the price of Arabica beans has been falling on the market, bean prices for specialty coffee companies have remained firm.

Among the big sellers, Starbucks is a perfect example. The company buys beans from companies that it has deemed "ethical sources," a term that encompasses forest conservation, worker treatment, and supplier transparency. Those aren't free, and the program drives up the cost of beans.

Starbucks will see some increase in profit due to the fall in bean prices, but that won't come for years. The company buys longer-term bean contracts, and the current decline might not hit the books until 2015. Even when it does, there's not going to be a direct correlation between the falling cost of beans and more cash for Starbucks, due to the extra cost of sourcing specific beans and the fact that other prices -- like milk and labor -- haven't fallen at the same rate.

Other winners from the bean fall
While Starbucks is waiting to see those gains, other companies are going to get a quicker hit. J.M. Smucker will see a bigger impact, as its coffee business has fewer of the extra costs associated with the Starbucks' retail model. Smucker is the owner of the Folgers brand and has an agreement with Dunkin' Brands' Dunkin' Donuts to sell its packaged coffee. Smucker has said that lower green coffee costs will have a positive impact on the bottom line this year.

Dunkin' Brands is winning in a bigger way than Starbucks on the coffee price shift. The company has seen Dunkin' Donuts franchisees increase operating profitability, in part due to the drop in coffee prices. While it doesn't realize those same gains on its packaged products -- since they're manufactured by Smucker -- the boost in operating profitability certainly gives the company a good pitch for potential franchisees, the company's bread and butter.

The future of coffee
While retailers are reveling in the low bean prices, the future could be a drastically different economic land. Coffee is under constant threat of climate change, disease, and unstable governments. The price spike seen in 2010 and 2011 could return, driving costs up for those companies that don't plan well or hedge correctly.

For now, coffee is stable enough -- even with the occasional spike -- that the real driver behind profitability and growth will be companies' operational rigor. Starbucks is growing its alternative drink and food lines, Dunkin' is focusing on growing its franchise model, and Smucker is branching out into new foods. Investors should focus on those drivers, while keeping a keen eye out for any major shifts in the future of coffee.

A stable future portfolio
There are companies even more dependent on commodity prices than Starbucks and Dunkin' Donuts -- companies that ride the ups and downs of the market. But as every savvy investor knows, billionaires like Warren Buffett don't make billions by betting on up-and-down stocks. They isolated their best few ideas, bet big, and ride them to riches, hardly ever selling. You deserve the same. That's why our CEO, Tom Gardner, has permitted us to reveal The Motley Fool's 3 Stocks to Own Forever. Readers can get their free copy of this guide by clicking here now to uncover the three companies we love. 

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Fool contributor Andrew Marder has no position in any stocks mentioned. The Motley Fool recommends Starbucks. The Motley Fool owns shares of Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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