Today, it’s hard to find someone who hasn’t heard of Starbucks, a major coffee roaster and café chain that operates globally, including in Vietnam.
Like many coffee companies, Starbucks has its financial year from October 1 to September 30. For instance, this year, Starbucks will close its books on September 30 to conclude its 2014-2015 financial year.
However, according to Kevin Johnson, the company’s CEO, Starbucks has accelerated forward coffee purchases for its 2016 financial year, which runs until the end of September 2016. Johnson mentioned, “The group had accelerated forward coffee purchases for its 2016 financial year.”
But why are they buying so far ahead? It turns out that “as arabica prices have remained well below last year’s average levels,” meaning that arabica prices are significantly lower than last year’s averages.
Indeed, earlier last month, futures prices fell to a low of 134.15 cents per pound before recovering to 141.50 cents per pound just before the futures market opened on Friday, April 24, 2015. The front-month contract is for July 2015, and the spot month is for May 2015. Therefore, the report said, “Futures hit 134.15 cents a pound early last month before staging some recovery, to stand at 141.25 cents a pound on Friday, on a front contract basis.”
Because of the recent drop in coffee prices, Starbucks locked in supply through September 2016. Johnson stated, “Due to the recent drop in coffee prices, we have been locking in supply for [fiscal] 2016,” meaning, “because coffee prices have dropped, we’ve locked in prices for the entire 2016 fiscal year.”
Why the term “lock” instead of “fix”? “Lock” means to secure and ensure that prices for specific months and quantities are firmly established. Johnson also mentioned that nearly 70% of the coffee purchased for fiscal 2016 has been locked in at prices more favorable than in fiscal 2015, saying “now close to 70% priced for [fiscal] 2016 at prices somewhat favorable to [fiscal] 2015.”
Thus, due to the lower arabica futures price this year, Starbucks has increased its hedging of coffee purchases compared to fiscal 2015, where only about 40% of their purchases were secured.
At the beginning of the 2014-2015 coffee season, arabica futures prices surged to a two-year high of 225.50 cents per pound.
Roasters, supermarkets, and restaurants usually buy coffee beans this way: purchasing for long-term delivery, sometimes for a year or more, with a consistent monthly delivery. By locking in prices (hedging), they can avoid price volatility. Clearly, once they’ve locked in up to 70% of their coffee purchases, their risk exposure is reduced to just 30%. This is a risk tolerance strategy where they can reward themselves when prices drop, without affecting retail prices, thus maintaining customer loyalty. Unlike gasoline prices, which fluctuate significantly and immediately, the fluctuation in coffee prices generally has minimal impact on customers’ wallets and the roasters’ margins.
Once Starbucks locks in prices and secures up to 70% of their coffee supply, they feel more comfortable with price fluctuations and are happy when prices drop, waiting for the lowest price to buy with minimal risk.
The daily market prices displayed online generally represent new contracts (outright), with higher financial risks, where speculators tend to ride the waves.
Here’s the full statement from Kevin Johnson:
“The group had accelerated forward coffee purchases for its 2016 financial year too, as arabica prices have remained well below last year’s average levels. Futures hit 134.15 cents a pound early last month before staging some recovery, to stand at 141.25 cents a pound on Friday, on a front contract basis. Due to the recent drop in coffee prices, we have been locking in supply for [fiscal] 2016,” Mr. Johnson said. The group was “now close to 70% priced for [fiscal] 2016 at prices somewhat favorable to [fiscal] 2015.” The extent of hedging represents a significant acceleration from that a year ago, when Starbucks said it had priced forward “more than 40%” of its coffee needs for fiscal 2015.”