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Markets

A Better Way to Get Your Fix

The coffee habits of Americans are changing, but you can still profit.

With consumers shunning Starbucks and its $4 Frappuccinos, firms that make brew-at-home coffee products are reporting strong sales and steady profits as the recession drags on. In particular, producers and distributors of premium coffee beans and coffee makers seem to be on a bit of a caffeine high.

More than half of all adult Americans drink coffee, and more of them are starting their day with a shot of java at home. Some 80% of coffee drinkers now make coffee in their own kitchens, says the National Coffee Association. But instead of trading down to no-name brands, caffeine junkies are imbibing the good stuff without shelling out extra money to have someone else brew it.

Oprah's pick. One beneficiary of current trends is Peet's Coffee & Tea (symbol PEET). Praised by none other than Oprah Winfrey, Peet's is growing rapidly. The number of grocery stores carrying its beans has doubled in the past four years, to more than 8,000. That's significant because Peet's derives more than two-thirds of its profits from its grocery, home-delivery and food-service sales. Peet's delivers freshly roasted beans directly to grocers. Its sales force pulls beans off the shelf when they get stale -- and makes sure the shelves stay fully stocked.

At its June 5 close of $29, Peet's trades at 29 times estimated 2009 earnings of 99 cents a share. But Stifel Nicolaus analyst Steve West says that Peet's should experience "a good five years of growth," driven mainly by the addition of more grocery customers. On average, analysts see profits growing 20% a year over the next few years, so the stock seems reasonably priced.

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The big winner in the coffee wars is Green Mountain Coffee Roasters (GMCR), a hot seller of beans and brewers (particularly to Costco). At $61, Green Mountain has doubled over the past year and is up 140-fold since 1998. The company makes the Keurig one-cup brewing systems that provide coffee cravers with a quick fix. Some worry the firm is virtually giving away its brewers so that it can sell more coffee packets. (Apparently, they've never heard of the razor/razor-blade strategy.)

Green Mountain is expanding its reach with a new distribution agreement with Wal-Mart, enhancing future growth prospects, says Canaccord Adams analyst Scott Van Winkle. Indeed, analysts see earnings growth of 25% a year over the next few years. Still, the stock, at 60 times estimated profits of $1.01 per share for the fiscal year that ends in September, looks rich.

A smaller player is Caribou Coffee Co. (CBOU), the second-largest coffee chain behind Starbucks. Caribou, which has about 500 coffee houses, has benefited from a shift in focus, increasing its sales to grocery stores and hotels. It also has a relationship with Green Mountain, which sells packets of Caribou coffee for its brewers. Shares of Caribou, which recently turned a profit for the first time since going public in 2005, soared from a low of $1.11 on December 29 to a bit more than $7 in June. At that price, it sells at a steep 54 times U09 earnings estimates of 13 cents a share, but a more reasonable 20 times 2010 forecasts of 35 cents.

A conservative way to get in on the spend-less-on-java movement is to buy shares of McDonald's (MCD), which, at $60, go for just 16 times estimated '09 earnings. While it has less snob appeal, the fast-food chain is pushing its "McCafé" lattes, which are cheaper than the lattes at Starbucks. Experts say the marketing muscle of McDonald's may win over doubters. "For a long time, an argument could be made that the McDonald's customer and Starbucks customer were not the same," says John Langston, senior analyst at Hodges Capital. "But that line has now grayed."

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We're less excited about Starbucks (SBUX), still the top coffee player, with a market value of $11 billion. The recession has hit Starbucks hard. True, it's cutting costs by shuttering stores. But it needs a new source of growth. At $15, the stock trades at 21 times expected '09 profits of 70 cents a share.