How Coffee Is Driving Economic Growth
Coffee consumption in the U.S. has been an integral part of our daily routine for decades, and today it's a similarly big part of life around the world, from traditional coffee-drinking markets like Europe to emerging markets like Asia. Consumed with meals and on its own, at home and on-the-go, coffee has in many ways become more than just a beverage—it's an iconic product rich with brand values and important social and cultural associations. And that's to say nothing of the caffeine.
T. Rowe Price has a number of research analysts who keep an eye on both the U.S. and international coffee sectors and the various companies that conduct business in it: consumer staples, supermarkets, electronics and kitchenware manufacturers, food retailers, restaurants, beverage and leisure companies. Three of them spoke recently about where they're seeing opportunity in coffee, from technological advances to shifting habits of consumption to new economic growth in emerging markets.
Among the companies that Ira Carnahan covers is Green Mountain Coffee Roasters, currently the biggest player in single-serve coffee in the U.S.
Carnahan says that single-serve systems—which allow you to make one cup at a time using "pods," rather than brewing a full pot—are a key driver of growth in the coffee segment, largely because they represent an innovation for consumers. "You're not having to open up a bag and keep it open for a week or so," he says, "and each person can choose what kind of coffee they want to have at any given time. Single-serve systems have the advantages of freshness, convenience, and variety."
Green Mountain's annual sales growth has averaged 64 percent over the last five years, Carnahan notes. "Similar to Starbucks from years ago, they started as a coffee roaster with a few retail shops, but then they decided to focus on the coffee rather than the retail stores. And then they bought Keurig, which is known for single-serve brewing machines. The Keurig business of brewers and pods now accounts for nearly 90 percent of the company's revenue."
Carnahan points out that single-serve coffee's rise in popularity in the U.S. is recent, relative to its adoption in Europe: "Single-serve coffee has been big over there, and the dominant company in the space has been Nestlé, which has some offerings in the U.S. but not nearly on the scale of what they have in Europe. For the first few years of single-serve's growth in the U.S., you had a number of players trying to establish themselves—companies like Kraft, Mars, as well as Green Mountain and others. Green Mountain emerged as dominant because they manufactured brewing machines and also had a deep offering of different coffees, and it turned out to be a lot easier to compete if you control both."
According to Carnahan, shipments of Green Mountain's K-Cups (their single-serve coffee pods) have grown strongly, from 50 million in 2006 to about 5 billion in 2011, as more consumers have become aware of the technology. That growth has opened the door to more competition in single-serve systems, with major brands like Starbucks preparing to enter the market.
Carnahan points out that the single-serve machine/coffee pod model is somewhat similar to the razor/razor blade model because the money isn't made on the razor; it's made on the blades. But unlike with single-serve coffee pods, the blades aren't interchangeable. "Razor companies like Gillette are constantly innovating their offerings so that the patent protection never wears off what's being sold. Green Mountain is trying to do that now because the core patents on their K-Cups expire this September. So they're in the process of rolling out a new machine, called the Vue, which will use recyclable pods and have patent protection until around 2020." (For an in-depth look at single-serve, read our article "The Big Trend in Brewing".)
Jonty Starbuck looks at both in-home and out-of-home consumption of coffee. Among the companies he follows is Whitbread, a leading coffee company in the U.K. whose Costa coffee chain competes with Starbucks, as well as Nestlé and Sara Lee.
Starbuck notes that coffee in general is not actually a high-growth category overall, with an about-average growth for the food and beverage industry, around 3 to 4 percent. But within that, he sees a move towards premium products that began in out-of-home environments and then spread to the home.
"Coffee is a particularly dynamic segment at the moment," he says. "It's really been driven by innovation, and the key driver of that is what's gone on in the out-of-home market. Starbucks has obviously been the leader, and then a number of companies have followed that global model. But in general it has encouraged consumers to want to trade up in terms of spending."
Starbuck points to the growth of Starbucks as an example of coffee's dynamism. "We're talking about 20 percent growth globally in the out-of-home channel, and high single digits in the U.S., mid-single digits in Europe. And there aren't many consumer segments that are growing in Western Europe at the moment. In emerging markets, it's more than 30 percent"
Similar to Carnahan in the U.S., Starbuck also sees opportunity in the at-home market, where consumers are buying more expensive products. "Nestlé has done a good job with soluble coffee in its Nescafé brand," he says, citing the company's premium instant coffee. "It's Nestlé's biggest brand globally, currently growing close to 10 percent. The consumer's interest in coffee has gotten people to trade up in-home, even in terms of soluble coffee, and then into the real premium products like Nespresso."
Nespresso is Nestlé's single-serve brand. "It is now US $3.5 billion of sales for them," Starbuck says, "which is still only maybe 5 percent of total company sales, but perhaps 30 percent of Nestlé's overall group growth. Then they've just introduced Dolce Gusto, a new single-serve offering, which is being rolled out into the U.S. Obviously Green Mountain Coffee is the incumbent, but that's the segment that Nestlé will be targeting, as will other companies like Kraft."
"If I look at coffee versus tea," he says, "tea is growing faster than coffee globally, but it's less interesting because there aren't as many premium opportunities. The opportunity that companies have now is to get people to trade up, to spend more to get a premium product, which is extremely interesting from a revenue and profit perspective." For example, he notes, the cost per serving of a Nespresso capsule is 10 times higher than the cost of a cup of coffee made from a jar of standard instant coffee.
"My suspicion is that the K-Cups and Nespresso and Dolce Gusto are sourcing the growth from the roast-and-grounds"—traditional at-home coffee brewing from purchased beans—"and really it's a consumer convenience issue. They don't have time to prepare an espresso at home; it's just easier to take a spoonful of Nescafé," he says. "What the K-Cups of the world are tapping into is both the taste preference that's been built up through the out-of-home channel and the convenience." (To learn more about the workings of the global coffee market, see our infographic "How Coffee Makes The World Go Round".)
Ashley Reed Woodruff, who covers Starbucks, Dunkin' Donuts, McDonald's, and Panera, says coffee is generating lots of consumer interest and therefore growth in emerging markets, especially in China, where coffee is not a traditional beverage. "China has gotten a lot of attention because it has historically been a tea-drinking nation," she says, noting that Starbucks and McDonald's both sell coffee there, as does Gourmet Master, a Taiwanese coffee company, under the brand 85°C.
"Coffee has taken on a lot more interest with younger consumers as a lifestyle product because of their interest in Western tastes," she says. "Starbucks is very well positioned as a premium Western brand, and tea is to some degree viewed as their parents' drink. But when you go to the stores in China most people aren't drinking the drip-brewed coffee that we're familiar with in the U.S., or even the double espressos that people drink in Europe—it's Frappuccinos, more of the sweeter drinks, that are most popular. That's often how people are introduced to coffee. The stores are also much busier in the afternoon, as the morning coffee ritual is just starting to develop. Starbucks's same-store sales growth in China has been in the double digits recently. They're opening new stores at a rate of around 15 percent right now, with a goal to have 1,500 stores in China by 2015."
"While tea will remain an important beverage in China, I expect coffee to continue to gain share. The U.K. was traditionally a tea-drinking nation, but people now drink more coffee than tea even there." And although single-serve coffee systems are being introduced and Starbucks's new Via single-serve soluble product has performed well, she says, "In China it's still more about going out to Starbucks or going someplace and having a coffee versus doing it at home." (For more on the Chinese market, see our article "For All the Coffee in China".)
"What a lot of people don't understand about Starbucks is that it's as much about the experience and the interaction with the barista as it is about the coffee," Woodruff explains. "It's great coffee, but a lot of people can roast and brew great coffee. That interaction is what has developed the brand, and given Starbucks the ability to take the brand into different products and expand throughout the world. It's more than just having the best coffee. It's not just a commodity—it's an experience."
Woodruff sees great potential for Starbucks's expansion into emerging markets: "Some consumers in China will keep their coffee cup and fill it with water after they finish with their coffee, and they'll hang onto it and walk around the street with it where other people can see the label—because it is about the Starbucks brand. When they go to the stores they stay there for three hours. It's where you would go on a first date," she adds. "It's as much about that experience in the community as about what's actually in the cup.
All funds are subject to market risk, including possible loss of principal. Funds that invest in a single sector are subject to greater volatility than those with a broader investment mandate. Investing in small companies is generally carries more risk than investing in larger companies. Funds investing overseas are subject to additional risks, including currency risk and geographic risk.
Panera represented 1.48% of the T. Rowe Price New Horizons Fund and 0.20% of the T. Rowe Price Small-Cap Stock Fund as of June 30, 2012; Panera was not held by the T. Rowe Price Value Fund as of June 30, 2012. The following securities were not held by the T. Rowe Price New Horizons Fund, the T. Rowe Price Small-Cap Stock Fund, or the T. Rowe Price Value Fund as of June 30, 2012: Starbucks, Green Mountain Coffee Roasters, Dunkin' Donuts, McDonald's, Nestlé, Kraft, Mars, Whitbread, Sara Lee, Gillette, Gourmet Master. The funds' portfolio holdings are historical and subject to change. This material should not be deemed a recommendation to buy or sell any of the securities mentioned.
T. Rowe Price Investment Services, Inc., Distributor.