Must-know risks: Why Starbucks should hedge its shrubs

Market Realist

Rethink your drink: An investor's guide to Starbucks Coffee Company (Part 5 of 9)

(Continued from Part 4)

Risk description

Starbucks (SBUX) acknowledges commodity price volatility as a primary risk factor for its operations. This company is exposed to commodity risks associated with dairy and sugar products in addition to coffee bean price, as it procures these goods to complement its primary product and uses them as inputs in various specialty beverages (like the Frappuccino). Hedging these risks is crucial to maintaining a stable supply of inputs and strong operations as a whole. Starbucks indicates that it uses derivative contracts to hedge commodity price risks. These contracts typically don’t have a lifespan longer than five years.

Green coffee bean futures prices saw a massive spike in April 2011, doubling from $1.37 (the price one year prior) to $2.99 per pound. This prompts the question, what drives the price of coffee beans? Specifically, what drove the price spike in 2011? First, low interest rates spawned low-cost debt, which investors bought and used to purchase commodities. This laid the groundwork for a commodities bubble, which was exacerbated by farmers’ poor expectations of environmental conditions for the year. Inclement weather damaged coffee crops, at which point supply couldn’t meet demand. Despite the negative implications of this sequence of events, Starbucks’ stock performance was largely unaffected (continuing to grow steadily) in 2011. The importance of efficiently hedging against input price to increase benefits in the industry is evident. Starbucks’ performance would have surely declined had it not been for the futures contracts in place.

Recent results

Fiscal year 2013 saw a decline of the price per pound of coffee beans of roughly $0.70. The hedging agreements were overall unfavorable for the company in FY2013, resulting in a net loss of roughly $24 million. However, the loss pales in comparison to the crippling losses that would be incurred if input prices took an unfavorable turn. The assurance of continued operations is worth more to the company than the loss resulting from price movement, as supply chain hindrances represent a much larger risk.

Continue to Part 6

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