Market Insights | Afternoon Coffee Break Part 2

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.