January 20, 2004

Coffee Rising, Margins Falling, Counter Intuition in Action

Three different men, three different coffee bulls. Greg Weldon (chart below), Hugh Hendry (dinner last night), and Marc Faber (last month's issue). Plus a question from a subscriber and a coffee stock. I'd do more research into coffee stocks right now...but I'm trying to put the finishing touches on the print issue of SI for February before my publisher sends over some enforcers. Hi Dan, Anything you can suggest on how to take part in a long-term bull market in coffee prices? Not being a real fan (at the moment anyway) of futures, it would be great to find some companies whose stock would move with coffee prices, somewhat at least. Any tips on where to look would be greatly appreciated. Thanks Well first, take a look at the long term bottom in coffee prices Weldon mentions. Having noted that, I would say that the trend of the last 100 years has been for all commodities to get cheaper. Prices rise during inflations. But inflation, as it has been famously said, is always and everywhere a monetary phenomenon. "Things" get cheaper because producing them gets cheaper as technology improves. Prices also come down as more people get in the production game. Falling prices are the norm. Then again....a multi-decade bear market is a long time for prices to be THAT low.... Second, I would not constitute the chart below as a tip, but a start, and an observation. Green Mountain Coffee (GMCR) trades at 18 times forward earnings and just over 1 times sales. It's not conventionally cheap. But if coffee prices do rise...this is a nice looking chart to go along with them. Note, this chart uses weekly closes with a 52-week moving average. You can't see the MA for the last few months because it's right on the trend line I've added to the chart. And it's also moving up. You also see that GMCR started moving up in 1999, well before coffee prices (apparently) bottomed. This makes sense. Green Mountain was paying less at the wholesale level and probably jacking up the prices on double espressos at the retail level...its margins getting ever wider. And in fact, if you look at GMCR's net margins for the last six years, they confirm this exaclty. In '98, the net profit margin was 0.5%. In '99, it rocketed up to 3.4% as coffee prices made new lows in the fall. The recovery in coffee prices in early 2000 ate into net profit growth, but the company still posted a 5% net margin. And when 2001 coffee prices resumed their slump, the net margin topped out at 6.1%. In the last two years however, margins have fallen. In 2002, the net margin was slightly lower at 6%. And through the first nine months of 2003, the net margin is 5.4%. In fact, the more you look at it, coffee stocks are probably good shorts right now. The cost of their raw material is increasing. And the desire of people to pay top dollar for coffee has probably already peaked. Designer coffee is a luxury unemployed Americans will indulge in. The most direct way to profit from rising coffee prices? Obviously the futures markets. Barring that, look for a country fund from a coffee producing country....more on that tomorrow.


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