By JACK HOUGH
For a 500 year-old beverage made from water and fruit pits, coffee sure has got investors buzzing.
Consider: The broad S&P 500-stock index sells for 13 times this year's earnings forecast. But Starbucks (SBUX)
Green Mountain Coffee Roasters shares went for 23 times earnings at the close of trading Thursday, but plunged after-hours on news that Starbucks intends to compete with it for single-serve coffee brewers. The stock has now lost more than one-third of its value since this column named it in a June roundup of food stocks that looked too expensive (see "3 Simple Food Stocks With Caviar Prices" ).
What has made coffee stocks so coveted? Several things. U.S. coffee consumption is rising a bit, especially among the young. A broad economic economy recovery has led consumers back to the latte shops. Single-serve machines, which use pods or packets and make brewing a cup manageable for the lazy, have given companies room to charge unit prices that were previously unthinkable for loose beans.
Investors remain fearful that economic growth could slow, so they're flocking to shares associated with stable demand. That has raised valuations for food, coffee and tobacco shares. And in Thursday's commodity trading, Arabica coffee beans--the better of two main species--hit their lowest price in 16 months. That could fatten profits for roasters and packagers.
One last thing, of course: Shares in general have surged of late, in part because yields on short-term savings accounts are painfully low and expected to stay so for the next couple of years. Risky stocks, it seems, look safer when compared against money-market yields of negative 2.5% after inflation.
But the coffee stock trade may have peaked. Valuations for the group already dwarf those of some other fast-growers, like Apple (AAPL)
This fall, Green Mountain will lose key patents protecting its single-serve machine business. That will allow more companies cash in on the market at first, including Starbucks and Peet's, but eventually, increased competition is likely to drive profit margins for all comers lower. Sales growth for these companies is already unremarkable. Peet's is expected to increase its sales by single-digit rates this year and next, and Starbucks, by barely double-digit ones. Sara Lee is struggling to increase sales at all. That doesn't leave a lot of room for earnings growth if something goes wrong with costs, like a reversal in commodity coffee prices.
At the same time, stock investors won't stay enamored of costly staples shares forever. If the economy continues recovering, they will be drawn to manufacturing, technology and consumer discretionary companies. And if the recovery stalls, stocks will broadly fall, and the costliest ones will likely fall hardest.
All told, stock buyers should regard Green Mountain's tumble as a cautionary sign. It's time to kick the caffeine habit.