Must know: How coffee price affected Dunkin’ Brands

Market Realist

Key Highlights: Dunkin' Brands Q4 2013 Earnings Report (Part 4 of 5)

(Continued from Part 3)

The performance of the coffee industry as a whole is less affected by coffee commodity price movements than the typical investor might expect. This is due to a series of hedging instruments to protect firms from short-term spikes in coffee pricing. Farmers will generally presell their crop; this is done a year or two in advance. This benefits the farmers who are certain there will be capital to maintain their land and equipment, as well as firms who will know that shortages in coffee will not drive prices up or leave them empty handed. However, futures contracts are not the only measures in place to mitigate price volatility risks. Dunkin’ Brands CEO Nigel Travis insists there is much more value added to a cup of Dunkin’ Donuts coffee than coffee alone.

How does Dunkin’ deal with spikes?

An investor might think that the price of a cup of coffee is closely tethered to the price of a pound of coffee beans. Following this logic, it would stand to reason that store managers’ sales would be negatively effected by price spikes. In turn, one would be led to believe the company as a whole would fare poorly as Dunkin’ Brands collects royalty fees on a percentage of franchises’ gross sales. This is important considering commodity analysts have predicted coffee prices to increase in the coming months. However, this logic does not do justice to the intricacies of this industry and particularly, Dunkin’ Brands.

Dunkin’ Brands outsourced supplier, the National DCP LLC., has hedged coffee prices with farmers for most of this calendar year for the company. This protects the company from rapid swings in coffee price. Likewise, Dunkin store managers are trained to utilize innovative pricing mechanisms. Chief among these is the managers are instructed to price differentiated products such as food, and intricate beverages higher when input prices spike. Customers are less able to intrinsically value these items than they are, as compared to a cup of coffee, which in their minds should cost “one dollar” wherever they go as opposed to “one twenty-five” during price swings. This way, both franchise and corporation margins remain largely unaffected.

Arabica vs. Robusta

During late January and early February of 2014, the price of coffee jumped 8% over an inclement weather concern. Warm weather brought on a drought in South America, hindering crop yield. Afterward, the price of Robusta coffee beans kept rising while Arabica prices fell. For this and the reasons mentioned above, Dunkin’ Brands share price was affected the least by these movements. An explanation for this is different players in the industry use different beans. Dunkin’ brands happens to be positioned well to accommodate this trend as it boasts, “We use 100% Arabica coffee beans” on the company website.

Continue to Part 5

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