Global coffee business – the growing obsession for China

The Chinese proverb, “Drinking a daily cup of tea will surely starve the apothecary” describes well the importance of tea in the local culture. Widespread cultivation and significant trade have been historically supportive of China’s high consumption per capita. However, coffee made its way in the domestic market over recent years, supported by a more westernised Chinese younger generation. While coffee consumption recorded double digit growth in recent years (around 18.5% on average for FY12–16 vs. only 2.6% in the US), overall consumption level remains much lower compared to other major markets (one-eighth of the US consumption in FY16, according to the US Department of Agriculture (USDA)). Urban centers such as Beijing, Shanghai and Guangzhou are at the core of the changes in traditional consumption pattern, driven by a growing middle class population and higher purchasing power.

Focussing on the Chinese retail coffee market, instant coffee holds the highest market share (lower pricing and large scale availability). However, this product segment is now close to saturation. Nestlé, market leader in instant coffee, benefits from Nespresso’s increasing adoption in the country. On the other end, the brewed coffee trade should benefit from the tailwinds of the increasing adoption of the ‘coffee culture’. According to Euromonitor, fresh coffee cup consumption is expected to increase at a steady pace of ~18% per annum through FY19. Global coffee shop chains such as Starbucks and Costa (Whitbread) have already identified such market growth potential and are actively expanding business in China. Starbucks, the current market leader with >2 400 stores (as of FY16) in the country, has planned further expansion and aims to double store count to 5 000 by FY21 (~500 store openings every year).

Moving on to coffee production, China’s southern province of Yunnan is well-known for its high quality Arabica beans. According to the USDA, the FY12–16 average annual growth rate for Arabica production was 9.8% vs. 2.9% for Brazil, the largest producer. International coffee makers have increasingly invested in local supply chain development to support domestic operations and meet the burgeoning coffee demand. Starbucks has one of its nine Farmer Support Centers located in Yunnan. The initiative supports local coffee farmers with solutions to improve crop quality and profitability.

Overall, we believe that China’s solid market growth potential should benefit global players operating locally such as Starbucks. The company expanded its presence aggressively via numerous store openings across China over recent years and expects to launch the first international Starbucks Roastery and Reserve Tasting Room (premium coffee products) in Shanghai by 4Q17. In this effort, the company has adapted store designs and offering to the local market sensitivities. Additionally, Starbucks has managed to connect to the younger population via the successful replication of its international customer engagement initiatives (My Starbucks Rewards, Mobile Order and Pay). Finally, partnerships with big market players such as Alibaba Group (ecommerce offerings) and Tencent (social gifting through WeChat) have allowed the company gain higher social media attention in the domestic market.

Ravi Kumar

Equity Expert

Data & recommendations as of 11 August, 2017 close

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