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Daily Intelligence Briefing

Monday, March 22, 2021

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The Daily Intelligence Briefing is published by McAlinden Research Partners. The report is provided to Hedge Connection blog readers once per week for free. Below is just one of the five sections that delivers Change-Driven Investment Themes everyday.

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A deep dive into a market driver with alpha generating potential.

Coffee Prices May Climb Higher on Weaker Harvests, Draining Surplus, and Rising Shipping Inflation

Summary: Several supply-side catalysts are set to whack the global coffee trade this year, setting the stage for a continued surge in futures like we’ve seen through the first quarter. On top of a significant drop-off in exports across many major markets, as well as the increasing spread of coffee rust fungus, shipping costs have been pushed up by lacking container supplies and resulting backlogs.

In the retail market, packaged goods firms are betting on more at-home consumption of coffee as the “work from home” economy persists and becomes a more permanent arrangement. Coffee chains like Starbucks, however, see a comeback on deck.

Related ETN & Stocks: iPath Series B Bloomberg Coffee Subindex Total Return ETN (JO), Starbucks Corporation (SBUX), The J. M. Smucker Company (SJM), Nestlé S.A. (NSRGY)

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Supply-Side Catalysts Pushing up Coffee Futures

As Forbes highlighted, February 2021 ended with coffee prices above the highest levels reached in 2020. Though futures have slipped lower in March, the upward trend remains intact – coupled with some bullish data on the supply side.

Though global coffee exports in the first four months of the 2020/21 season (October-September) rose 3.7%, the International Coffee Organisation (ICO) recently reported that exports reversed course and declined by 3.4% in January.

While Brazil’s shipments surged, most other markets saw marked declines in their output. Per Reuters, Africa’s exports in the first four months fell by 13%, Asia & Oceania’s exports declined by 3.9%, while exports from Mexico & Central America slumped by 17.5%, as the region was hard hit by hurricanes Eta and Iota.

Brazil’s surplus of arabica beans has carried the global coffee supply in the early season, but that kind of output is not expected to continue. Production of arabica beans in Brazil is expected to drop by about a third in the 2021-22 season amid dry weather, adding to lower-than-expected output forecasts from Central America. Just last month, Arabica futures touched their highest level in more than a year.

Output of robusta beans, the “second rate” variety of coffee that’s typically cheaper and easier to grow than arabica, is also down in several key markets.

When factoring in February’s expected shipments, Coffee export revenue for Vietnam, the world’s foremost producer of the robusta bean, was likely down 15.8% YoY to $473 million for the first two months of the year.

Uganda may not immediately come to mind when one thinks of coffee production, yet it has become the world’s 8th largest producer of coffee, specializing in robusta but growing some arabica too. Coffee exports from the African country declined 4.9% YoY in January.

Making things worse for the supply of specialty roasts, rust fungus – a coffee farmer’s greatest nemesis – has begun to spread again. In late 2020, the Roya finally reached Hawaii, home of the popular Kona brew coffee.

Back in 2019, an epidemic of the rust fungus (“Roya” in Spanish), a dangerous plant disease likened to cancer, which grows quickly in dry, warm climates, whacked Central America, destroying entire coffee plantations. Costa Rica, one of Central America’s smaller producers, but well-known for its high-quality beans was hit especially hard. As MRP highlighted at the time, the country saw a staggering 66% fall in shipments in October 2019, giving them their lowest monthly export volume in almost 40 years, followed by another 30% slide in November.

Until this fall, Hawaii was one of the last coffee-growing regions in the world still untouched by rust, which travels on the wind and can infect many trees before it is even noticed by farmers. According to Food & Wine, Melissa Johnson, a research biologist at the Daniel Inouye Pacific Basin Agricultural Research Center (PBARC), had surveyed 25 coffee lots in January and about 65% of those had coffee leaf rust on about 5% of their leaves. In February and the average rate of infection had jumped to nearly 10% and some trees had started to lose their leaves.

Though Hawaii and other coffee producing nations have contingency plans in place to deal with the Roya, the cost of managing coffee rust, a downturn in supply, and an uptick in coffee berry borer beetles across the islands, will likely get passed along to consumers.

A final catalyst for a potential breakout in coffee futures is significant cost inflation for major coffee processors, mostly related to transportation. MRP has repeatedly highlighted the global shortage of shipping container supplies along key maritime routes, driving up shipping rates and backlogs across multiple industries. That displacement is having a heavy effect on prices in the international coffee trade. As Oliver Stormshak, chief executive at Washington’s Olympia Coffee Roasting, told CNBC earlier this month, “We’re currently signing contracts for delivery in the summer and fall, and those prices have gone up quite a bit, about 15% increases on everything.”

Investors can gain exposure to coffee futures via the iPath Series B Bloomberg Coffee Subindex Total Return ETN (JO).

At-Home Packaged Coffee Bets on Beating Out the Coffeehouse Brews

Back in October, MRP noted that many consumers were still consuming many more cups of coffee at home instead of in coffee shops and restaurants, despite easing pandemic restrictions. Consumer habits for the period in Aug. 26 to Sept. 3 were similar to those in a January poll, with six in 10 Americans drinking coffee everyday, at an average of 2.9 cups per day. Around half of the survey respondents said they stopped having coffee in restaurants, while 22% have not drunk it in the workplace.

Though some of the loss in retail traffic has been picked up by app-based ordering from coffee chain franchise locations, a sizable chunk of coffee demand has also shifted toward grocery stores or online subscriptions for periodic delivery. Online sales rose 57% as many roasters started to sell ‘coffee subscriptions’ to consumers willing to cut trips to grocery stores.

MarketWatch notes that packaged goods giant J.M. Smucker Co. (SJM), owner of Folgers and Dunkin’ Donuts coffee, believes this trend will continue into 2021, as many workers will keep using their home offices even after the COVID-19 pandemic begins to subside. During their most recent earnings call in late February, Chief Executive Mark Smucker noted that, “Approximately half the US workforce is expected to work remotely on a part- or full-time basis post-pandemic compared to just 30% before the pandemic, driving increased at-home breakfast and lunch occasions, benefiting our coffee and consumer foods business,” he said, according to FactSet.

As Bloomberg notes, coffee was one of the motors of Nestlé’s (NSRGY) sales growth last year and makes up the bulk of the company’s $24 billion beverage business. Nespresso, the company’s line of high-end coffee blends and machines, has become more popular in recent years as Nestlé has taken some bolder steps to boost its US coffee business.

While Nespresso makes their own coffee “pods” for their machines that they market online and at retail locations, they’re looking to build out their presence on both kitchen and coffeehouse counters.

Back in 2018, Nestlé inked a $7.15 billion partnership with Starbucks (SBUX) that turned out to be a very beneficial symbiotic relationship during the pandemic. Starbucks was able to get their coffee into Nespresso pods for rising at home consumption, and now, with consumers returning to Starbucks retail locations, an increasing number of the company’s contactless coffee machines are being rolled out globally – particularly in China.

Just last year, Nestlé opened almost 900 Starbucks counter locations in China. Asia’s largest economy may be see the biggest comeback for coffee shops since COVID-19 restrictions are almost nonexistent across the nation.

Wedbush Securities Analyst Nick Setyan writes that Starbucks “has established itself as a clear market leader” in China. He recently raised his rating on Starbucks to Outperform from Neutral, lifting his price target to $124 from $108. Setyan’s recent research, cited by Barron’s, suggests same-store sales for the coffee giant may be trending ahead of consensus estimates, facing easy YoY sales comparisons in the months ahead, because of the café closures that dominated early 2020.


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