By Cornelius Zeeman and Isaac Coetzee,
Fairtree Portfolio Manager and Equity Analyst

Starbucks Corporation Overview.

Starbucks Corporation, formed in 1985, has grown to become the world’s leading roaster, marketer, and retailer of speciality coffee. Operating across 86 markets with a global presence of 40 199 stores, Starbucks continues to shape the speciality coffee industry. In fiscal year 2023, its retail sales mix largely comprised beverages (74%), followed by food items (22%) and other products (4%).

Coffee Channels.

Starbucks distributes its coffee through three key channels:

1. Retail stores: Starbucks supplies coffee directly to its company-owned stores, representing its direct exposure to the coffee market without considering the influence of hedge activities.
2. Licensees: Starbucks sells coffee to its licensed stores for resale, which accounts for 48.5% of its total stores. In this arrangement, Starbucks also earns royalties based on the sales generated by these licensees.
3. Third-party partnerships: Starbucks also collaborates with companies like Nestlé to reach a wider market, selling coffee and earning royalties from these partnerships.

On the procurement side, Starbucks employs hedging strategies and supply contracts to stabilise coffee costs, mitigate price volatility, and ensure a reliable future supply. On the selling side, Starbucks enjoys a natural hedging effect. When coffee prices rise, the increased selling prices to licensees and third parties help offset rising costs. Additionally, higher sales from these partners result in increased royalty earnings, further safeguarding profitability.

Coffee Price Impact on Starbucks.

Coffee costs generally account for 10%-15% of Starbucks’ “Production and Distribution Costs”. Graph 1 below shows Starbucks’ gross profit per quarter and gross profit margin to track the cost of sales relative to sales. Monitoring Starbucks’ quarterly gross profit and gross profit margin shows how sales performance and cost management have contributed to its profitability. This stability suggests that significant rises in underlying costs, such as coffee prices, have had a minimal impact—largely due to effective hedging practices and Starbucks’ natural hedge effect.

Coffee represents a relatively small portion of the cost of goods sold. Starbucks recently announced plans to expand its in-house coffee farming operations, with new farms in Costa Rica and Guatemala, and planned expansions into Africa and Asia. Currently, Starbucks sources around 3% of the world’s coffee volume annually, working with over 450 000 farms to meet demand, according to the company’s estimates.

Graph 1: Starbucks’ gross profit per quarter and gross profit margin

Source: Fairtree

Recent Share Price Movement.

Starbucks has experienced a significant rise in its share price following the announcement of a leadership transition. Brian Niccol, the former CEO of Chipotle, is set to take the helm starting 9 September 2024. Widely respected in the restaurant industry, Brian Niccol is expected to address some of Starbucks’ recent challenges that have contributed to its underperformance. Investors are optimistic that his expertise will help revitalise the brand and drive future growth for Starbucks.

Graph 2 below illustrates a strong correlation between comparable sales growth and share price. The share price surged nearly 25% on the day the new CEO was announced, reflecting strong investor confidence in Brian Niccol’s leadership and vision for Starbucks.

Graph 2: Correlation between comparable sales growth and share price of Starbucks

Source: Fairtree

*Comparable sales growth is an indicator of organic sales growth
**3Q21 growth rate of 73%

Conclusion.

In conclusion, Starbucks Corporation has built a resilient and strategic approach to navigating the complexities of the global coffee market. With the planned expansion into in-house coffee farming and new markets, Starbucks is poised to deepen its footprint in the speciality coffee industry and drive long-term value. The company’s innovative approaches and adaptive strategies ensure its position as a global leader in coffee.

By Cornelius Zeeman and Isaac Coetzee,
Fairtree Portfolio Manager and Equity Analyst

Coffee starts its journey as a green bean, the unroasted seed of the coffee cherry. These green beans are harvested, processed, and eventually roasted to become the coffee we know and love. While there are many varieties of coffee, two primary types dominate the global market: Arabica and Robusta.

Arabica vs. Robusta.

Arabica coffee, known for its smooth, complex flavour, characterised by mild acidity and a variety of aromatic notes, is preferred in speciality and premium markets. It’s the preferred choice for major coffee houses like Starbucks. 

On the other hand, Robusta coffee delivers a bolder, more bitter flavour, with higher caffeine content and a fuller body. Often used in instant coffee and espresso blends, Robusta contributes richness and adds a creamy layer, known as crema, to espresso.

Robusta is generally more affordable than Arabica for several reasons. It thrives at lower altitudes and in warmer climates, requiring less intensive environmental management. Robusta plants also have higher yields and lower water needs, contributing to reduced production costs. Furthermore, it’s higher caffeine content makes it more resilient against pests, such as the coffee borer beetle, acting as a natural pesticide. In contrast, Arabica requires cooler, higher altitude growing conditions and more careful cultivation, making it a more costly option.

Image 1: Key differences between Arabica and Robusta

Source: International Coffee Organisation

Supply and Demand.

Arabica thrives at higher altitudes and is primarily produced in Brazil, which accounts for 48% of global Arabica production, followed by Colombia (12%), and Ethiopia (8%). Robusta, being more adaptable, is predominantly produced in Vietnam (36% of global Robusta production), Brazil (28%), and Indonesia (12%). 

Brazil is the largest combined producer of both coffee types, accounting for 40% of global production, followed by Vietnam with 16% and Colombia with 7%, as shown in Graph 1.

On the consumption side, the European Union and the US together account for 40% of global coffee consumption. Both regions import most of their coffee, as their domestic production is insufficient to meet their consumption needs.

Graph 1: Coffee production vs. consumption by region

Source: USDA & Fairtree

Challenges in Global Coffee Production.

The coffee industry faces significant risks, including unpredictable weather patterns, pest issues and rising production costs. These challenges threaten both the quantity and quality of coffee. Major coffee-producing countries have each faced notable disruptions:

• In Brazil, a severe drought followed by frost in 2021/22 caused a 17% decline in coffee output, damaging crops extensively.
• Vietnam saw production declines in 2020/21 due to dry weather and low coffee prices, which led to reduced irrigation and fertilisation efforts, followed by another drop in 2022/23 driven by soaring fertiliser costs and adverse weather conditions. The high fertiliser costs and lack of price incentives diminished the use of essential inputs, resulting in decreased yields.
• Colombia, the second-largest Arabica producer, experienced a 31% drop in coffee production during 2008/09 due to heavy rains and coffee rust, a fungal disease that causes leaves to drop, reducing the yield and quality. The country’s production further declined by 12% in 2021/22, largely due to La Niña-related weather conditions and high fertiliser prices. This trend persisted into 2022/23.

Graph 2: Year-on-year growth rates of top coffee producers

Source: USDA & Fairtree

What’s Driving the Surge in Coffee Futures Prices?

In 2021/22, coffee consumption exceeded production, leading to a decline in ending stocks that continued through to 2023/24, as shown in Graph 3. This situation was exacerbated by soaring fertiliser prices in 2022, exacerbated by the Russia-Ukraine conflict, which increased production costs and reduced fertiliser use. Additionally, coffee production faced risks from unpredictable weather and other supply chain issues, such as rising freight rates and regional conflicts like the Red Sea conflict. These factors contributed to a sharp rise in future prices for both Arabica and Robusta coffee. 

Graph 3: Global coffee production and consumption trends over time

Source: USDA & Fairtree

Futures pricing often reflects anticipated supply and demand imbalances, signalling potential future shortages or market disruptions. Consequently, the high futures prices we are currently seeing, as shown in Graph 4, indicate ongoing concerns about future supply constraints and production challenges.

Graph 4: Coffee future prices

Source: USDA & Fairtree

Conclusion.

The coffee industry, while deeply rooted in tradition, is facing evolving challenges that impact both production and pricing. Arabica and Robusta beans, with their distinct growing conditions and flavour profiles, highlight the complexity of the global coffee market. From shifting weather patterns to rising production costs and geopolitical tensions, these factors shape the supply and demand dynamics that ultimately influence the price of your daily cup of coffee. 

Stay tuned for part two of our article, where we explore how Starbucks navigates these industry dynamics and maintains its market leadership.

Introduction

The beginning of the third quarter saw the national election resulting in more positive results than what was expected. This after the formation of a Government of National Unity (GNU). The GNU partners are more centrist, which may provide better accountability, implementation, and drive economic reforms.

Foreign investor flows are increasing, with growth expectations improving due to markets anticipating that the South African Reserve Bank (SARB) will cut interest rates. The South African Reserve decision to decrease interest rates by 25 basis points, was well received by the market and the scope for more cuts widened towards the end of the year. This was strengthened as the fuel price and inflation continue to drop and the rand strengthened during the month of September.

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Kalpana Systems has secured a €3.5 million investment from investors Fairtree Elevant Ventures, SIG InnoVentures and the Energy Transition Fund Rotterdam. This funding will enable the Delft-based machinery manufacturer to bring its revolutionary spatial Atomic Layer Deposition (sALD) technology to the market. This technique is essential for applying ultra-thin layers crucial for applications, such as next-generation solar panels, batteries and packaging. The machine developed by Kalpana Systems unlocks transformative advancements with faster production speeds, reduced cost, and efficient use of valuable raw materials needed in the energy transition.

Production with atomic-level precision

Thin films and specialised coatings are the enabling technologies for many ground-breaking innovations, including OLED screens, solar cells and battery technology. To make these products more efficient, expand their lifetime, and miniaturise them further, it is critical that the thin film that is incorporated in the product, or covering the product, is of a consistent and high quality.

Atomic Layer Deposition (ALD) has long been recognised as a powerful method for thin film deposition, where these coatings can be built up atom-by-atom and can transform the performance of films and their applications. These coatings play a vital role in enhancing functionality and offering protection, such as improved electrical conductivity, corrosion resistance, and moisture protection for solar cells and catalysts. By precisely creating layers at the atomic scale, the machine optimises the use of costly materials, such as lithium, iridium, and copper, resulting in cost savings and material efficiency.

However, this process is slow and costly, and thin film deposition must occur rapidly and economically to facilitate large-scale adoption. Overcoming the challenge of delivering high production throughput with high quality can unlock transformative applications in energy storage, solar cells, flexible electronics, and sustainable packaging, all crucial to the Energy Transition. Kalpana Systems offers a solution to this challenge.

Clever design for a broad range of production processes

Kalpana Systems has revolutionised the process by developing a machine capable of producing high volumes of thin films continuously using Spatial Atomic Layer Deposition (sALD). Through the innovation of the flexible substrate transport system, layers can be continuously deposited at high speeds, radically reducing the cost per square meter for each applied layer.

Kalpana Systems’ unique 3D helical design ensures consistent, high-quality sALD application at an industrial scale over extended periods, boosting the speed of existing ALD processes by a factor of 1000. Additionally, the machine’s design allows for seamless integration into existing production lines, making it versatile for a wide range of applications. Kalpana Systems aids companies in incorporating the proven applications of sALD into scalable and profitable production processes. This paves the way for applications from more cost-effective, lighter, and more efficient flexible solar cells to longer-lasting, high-performance batteries.

Diederick Spee, CEO of Kalpana Systems, stated, “With our machine producing thin layers quickly, efficiently, and affordably, we enable promising technologies to become viable. The boost to the energy transition that Kalpana Systems can provide is now within reach with this capital injection from Fairtree, SIG, and the Energy Transition Fund Rotterdam.”

David Evans, Managing Director at Fairtree Elevant Ventures, said, “Kalpana Systems has an incredibly talented team and ground-breaking technology which can crack ALD at scale. Kalpana is now bringing their technology to market, and we look forward to supporting them on this exciting journey. Their success can contribute to significant advancements in the production of next-generation technology, such as batteries, solar cells and packaging worldwide”.

NoPalm Ingredients, the pioneering Dutch biotechnology company producing yeast oils, announced the successful closure of a €5 million Seed funding round. The funding round was led by Rubio Impact Ventures, one of Europe’s foremost impact venture capital firms, and co-led by Oost NL, Fairtree Elevant Ventures, and family office Willow Capital Investments with participation from The Netherlands Enterprise Agency (RVO) and other private investors. The investment will accelerate the company’s mission to provide a local, circular, and sustainable solution for the global palm oil market.

Technology and innovation

Founded in 2021 by Lars Langhout and Professor Dr. Jeroen Hugenholtz, NoPalm Ingredients aims to address the environmental and supply chain challenges of conventional palm oil, which is found in 60% of supermarket products. NoPalm Ingredients employs a unique fermentation process using non-GMO proprietary yeasts combined with a patented low-capex technology. This process transforms upcycled, locally sourced agri-food sidestreams, such as potato peels and whey permeate, into yeast oils. Feedback from customers indicates that NoPalm Ingredients’ oils are an ideal drop-in replacement for palm oil, requiring no recipe reformulation and achieving price parity. This is made possible by the use of agri-food sidestreams and an asset-light technology that is quick to scale. Additionally, the technology also boasts a 90% reduction in CO2 emissions and a 99% decrease in land use compared to traditional palm oil production. NoPalm has proven its oil quality with pilot partners, including industry giants Colgate-Palmolive, Unilever, and Zeelandia.

Palm oil is cheap, incredibly versatile and widely used in almost every fast-moving consumer good, from your toothpaste to my newborn’s infant formula. The problem is that global demand for palm oil grows by 4% annually, and there’s no strategy to meet the additional 22 million tons needed by 2030 without clearing rainforests 1.5 times the size of Ireland. With new regulations banning deforestation-related products, European companies can only source sustainably certified palm oil, which excludes 83% of current supplies. This will drive price increases that will affect every family in Europe. Often, the answer isn’t to prohibit a product but to step back and create a superior alternative that naturally compels a switch. This funding is pivotal for us to demonstrate large-scale production and reach our next milestone of producing 1,5 million kilograms of sustainable oil annually, solidifying our role as a trusted partner in the food and personal care industries. We are on track for industrialisation and commercialization in 2025.

— Lars Langhout, CEO & Co-founder of NoPalm Ingredients

NoPalm Ingredients has demonstrated the ability to make a cost-effective drop-in replacement for palm oil and other lipids that we believe will revolutionise the industry, address the massive environmental challenge of palm oil production and harvesting as well as solve myriad supply chain pain points for customers. Further, NoPalm Ingredients’ innovation allows them to upcycle industrial food waste streams which recovers carbon and creates value from waste, creating tremendous benefit. NoPalm Ingredients has demonstrated both the technical capabilities as well as the commercial partnerships to rapidly scale their technology and make an incredible impact across a wide swathe of industry and we look forward to support them on this exciting journey ahead.

— David Evans, Managing Director at Fairtree Elevant Ventures

Introduction

US financial conditions remain tight with increasing signs that growth may be slowing. Corporates are finding it harder to pass on higher prices to consumers adding pressure to profit margins. Valuations and earnings expectations remain elevated. Outside the US valuations seem fairer with emerging markets trading at attractive valuations. Local bond yields are attractive. Local core inflation remains contained but upside risks are high. Headline inflation has peaked, and we expect the SARB to cut rates later this year. The sovereign credit premium has compressed but remains high. Global developed market bonds remain attractive, given the outlook for softer growth.

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By Cornelius Zeeman and Thembinkosi Kweyama,
Fairtree Portfolio Manager and Equity Analyst

In our previous article on energy drinks, we explored the rise of this drink category in the global liquid refreshment beverage sector. Despite their niche status in the US non-alcoholic and alcoholic beverage markets, energy drinks have secured a 2% market share by volume and 4% by dollar sales. Over the past two decades, this market has been dominated by a duopoly, with Monster Energy and Red Bull collectively commanding over 65% of volume and dollar sales, as shown in Graph 1. Meanwhile, carbonated drinks and bottled water drive significant volumes, while beer and spirits lead in dollar value.

Graph 1: Beverage market share in the US market

Source: BoFA

Different types of energy drinks.

The US market has been a testing ground for product innovations by brands like Red Bull and Monster Energy. Recently, Celsius has gained popularity among gym enthusiasts and health club members, positioning itself strongly within the performance energy drink category. Performance energy drinks are generally low in sugar but high in caffeine, promising benefits such as increased metabolism for up to three hours, as marketed by Celsius. This innovation has driven the performance energy drink segment to a 21% market share, largely due to Celsius’s positioning as a wellness beverage in the low-sugar category.

Graph 2: Drivers of incremental consumption (May 2022 wave)

Source: UBS survey

Table 1 below shows Nielsen data that track market share trends in dollar sales and volumes in convenience and retail channels since April 2019. Note: Monster Energy brands are highlighted in grey, including the newly acquired Bang brand.

Table 1: Nielsen market share trends in US$ sales and volumes

Source: Nielsen Data

Distribution dynamics.

Table 2 below shows that Monster Energy’s core products are typically more affordable than their competitors, partly because their cans are usually twice the size of a Red Bull can. This size difference explains the disparity between their dollar and volume shares. Another key factor is the variety of products available per store. Effective distribution plays a crucial role here. Celsius’s substantial market presence is bolstered by its partnership with PEPSICO, initiated last year, while Monster Energy has been leveraging the Coca-Cola Bottling Network since 2015 for its international expansion.

Table 2: Pricing and products in store shelves by the respective companies

Source: Nielsen Data

Conclusion.

The energy drink category has outperformed other beverage categories, and this will likely continue. Category shifts and innovation in the market are seeing new entrants like Celsius come in and partnering up with Pepsi for distribution to cement their share on the retail shelves. Strategic distribution partnerships and brand positioning are vital, as evidenced by the distinct paths taken by leading brands to engage consumers.

Introduction

The South African Reserve Bank (SARB) is expected to follow suit with rate cuts as local inflation risks remain manageable. Although the SARB’s push for a lower inflation target implies higher policy rates initially, they may decrease as inflation expectations align with the new target. Asset volatility continued in South Africa due to election-related news during the second quarter of 2024. The ruling ANC party faced a significant setback, securing only 40% of the vote, necessitating efforts to form a functional government. The trajectory of stability, policy certainty, and the reform agenda over the next few years will largely depend on these developments.

GEO – POLITICAL TEMPERATURE MILD MODERATE GETTING HEATED 6 Local assets performed well, with bonds rallying more than 5% and the rand appreciating by more than 3% towards the end of the quarter. General retailers and banks also rallied by 15-20%. Local asset prices may continue to benefit from better electricity supply, improved political certainty and expected rate cuts.

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Introduction

US financial conditions remain tight with increasing signs that growth may be slowing. Corporates are finding it harder to pass on higher prices to consumers adding pressure to profit margins. Valuations and earnings expectations remain elevated. Outside the US valuations seem fairer with emerging markets trading at attractive valuations. Local bond yields are attractive. Local core inflation remains contained but upside risks are high. Headline inflation has peaked, and we expect the SARB to cut rates later this year. The sovereign credit premium has compressed but remains high. Global developed market bonds remain attractive, given the outlook for softer growth.

Download the report