This Is How We Brew It: Coffee Deep Dive

Overview:

• The aging U.S. market is expected to increase consumer coffee intake.
• Iced drinks, loyalty plans and digital experience are drawing customers out of the home and into coffee shops.
• Increased sales of premium and iced drinks carry an inherent increase on gross margins.
• A digital customer experience is among the reasons younger demographics return to coffee shop restaurants.
• At-home coffee consumption could continue to decline as prices rise in order to maintain profits against higher bean costs.

The TD Cowen Insight

We forecast a 6% U.S. coffee 10-Year CAGR aided by an aging U.S. population paired with proprietary survey and industry data that suggests coffee intake grows in older cohorts. Within our proprietary top-down and bottom-up coffee models, we expect coffee shops to gain share from at-home given savviness with iced drinks & digital that drives Gen Z stickiness.

The Coffee Shop Experience versus At-Home Coffee

We are bullish the coffee shop category will be the second-fastest growing U.S. restaurant category over the next 10 years, which we view as differentiated from the conventional wisdom of a more saturated market. Fueling our view is U.S. Census data indicating an aging population and data from our proprietary survey and the National Coffee Association, which indicate that coffee consumption grows as consumers age.

In our view, restaurants in the coffee category with a beverage portfolio that skews iced and those that see most transactions attached to loyalty programs and digital are poised to see a tailwind of same-store sales beats over the medium term.

We are skeptical about whether at-home coffee will capitalize on the aging population like it has in the past. Machine manufacturers have struggled to develop a compelling at-home cold coffee device that replicates the coffee shop experience, and the packaged coffee leaders have struggled to keep pace with changing consumer preferences.

Ten-Year Coffee Metaverse Outlook

We built a top-down and bottom-up industry model spanning the entire coffee metaverse to determine the appropriate CAGR for the U.S. coffee market over the next decade (to 2033).

Survey data paints a picture of desirable demographics for coffee shops given the 18-24 age cohort's preference for coffee outside the home, as well as for iced beverages and the convenience of digital. We also highlight our work on privately-held concepts in the rapidly growing drive-thru coffee shop segment based on our analysis of Franchise Disclosure Documents (FDD's). Our model utilizes data from the TD Cowen Consumer Tracker (proprietary Dectiva survey), the National Coffee Association (NCA), Euromonitor and company specific insights.

Iced Beverages and Digital Builds Stickiness with Gen Z

Within our coffee model (2023-2033), we forecast share shift to coffee away from home (6.7% 10-Year CAGR) from coffee at home (2.5% 10-Year CAGR). This shift is aided by coffee shops' proficiency with iced beverages and digital experience to build stickiness with Gen Z. We forecast a weighted average 2.8% 2025-2033 industry coffee shop same-store sales, while we estimate net restaurant growth will be a larger contributor to coffee shop industry sales growth at 3.8%.

We forecast coffee-market dollars will shift from 25% coffee-at-home/75% coffee-away-from-home in 2023 to 19%/81% in 2033, respectively. We also expect the 18-plus population who identify as coffee drinkers to grow to approximately 74% in 2033 (up from approximately 68% in 2023 and 63% in 2020) on a weighted-basis across age cohorts in-line with the historical cadence observed by the National Coffee Association from 2020-2024.

While our industry model focuses on sales, it's important to highlight that growth in the coffee category is fueled by iced beverages and premiumization. Both product classes have the side effect of a positive impact on gross margins. Indeed, iced coffee is typically higher margin than hot coffee given a higher price point for larger volume beverages where ice is a primary ingredient. For the coffee shop category, we believe this shift will lead to normalized pricing of 1%-2%, which trails the 20-Year average for food-away-from-home (i.e., the wider restaurant industry) of 3.4%.

Price Rises Could Offset Higher Coffee Bean Costs

In the coffee shop category, one key monitoring point will be the ongoing unveiling of turnaround plans of covered companies that will be updated during quarterly earnings calls. We posit the strategies will be focused on gaining Gen Z market share. Looking beyond these updates shared on earnings calls, we will be monitoring beverage innovation of covered companies – particularly those with iced coffee and energy drinks. We will also continue to monitor annual FDD's of emerging drive-thru oriented coffee concepts to help provide insights into growth and unit economics. Our monitoring includes those concepts identified in the full report below and any newer concepts that are currently sub-scale.

In the at-home coffee category, we expect market leaders to continue prioritizing profits by raising prices to offset higher coffee bean costs. This is likely to result in another year of volume declines from consumers cutting back on their rates of consumption or waiting for promotional discounts before buying. Higher coffee prices in relation to muted inflation across the broader grocery store may exacerbate the elasticity.