What do plunging coffee prices mean for Starbucks?
Head of Equity Strategy
Summary: Is the steep decline in Arabica Coffee prices likely to continue?
Rapidly falling coffee prices are a function of mainly three factors: rising supply outpacing demand, a higher USDBRL and increasing speculative short positions driven by hedge funds playing one of the steepest futures curve (contango) in the commodity market. The contango in coffee futures means that speculative short positions capture positive roll yield if the underlying spot price does not move much as the futures price will “roll down” towards the spot price as the futures contract gets closer to expiry.
Arabica Coffee (continuous), monthly observations
Starbucks typically hedges around half of its coffee needs more than a year into the future. As a result, it does not capture the full effect of lower spot prices immediately. But as coffee prices have continued to fall, Starbucks can now lock in coffee one year into the future at very low prices, especially given the firm never lowers its retail coffee prices.
Starbucks weekly share price
Starbucks shares are also valued at a 50% valuation premium to US equities on the EV/EBITDA valuation multiple. Another thing to consider for Starbucks investors is the fact that sell-side analysts are having difficulty finding upside catalysts to justify the current share price. Sell-side analysts have a consensus target price of $70, which is around 5% lower than yesterday’s close.
Our Equity Radar model is playing the devil’s advocate against the aforementioned risks as the company’s high quality score combined with lower-than-average balance sheet leverage and lower downside volatility are offsetting an above-average valuation.
Equity Radar model