Seeking Alpha
Profile| Send Message|
( followers)  

The current low price of coffee can be best exploited through the coffee exchange-traded notes iPath Pure Beta Coffee (NYSEARCA:JO) and the iPath DJ-UBS Coffee TR Sub-Index (NYSEARCA:CAFE). Investors will have to endure weakness in the markets and 0.75% fund expenses until prices increase to higher levels.

Unfortunately, many coffee companies that will benefit from the current low price of coffee are trading at price multiples that make them unattractive.

Current Low Coffee Prices

Robusta coffee increased to the highest level compared to the last four months in London due to a decrease in sales from Vietnam, the biggest grower of the variety, as a result of the Lunar New Year. According to Volcafe, a coffee unit of ED&F Man Holdings, Vietnamese farmers who are seeking higher prices are holding back beans and may increase "retention" after Tet, it is a festival that celebrates the Lunar New Year.

A broker of ABN Amro Markets U.K. said:

The principal hedging origin, Vietnam, is now heading into holiday season. This does not completely remove selling but means it may be more sporadic over the next week or so.

For March, Robusta coffee's delivery was $12 a ton more expensive than beans from May, reversing a $10 per ton discount in the first trading day of the week. Arabica coffee is fetching the lowest premium over Robusta in last four years as reserves in ICE-monitored warehouses was 2.6 million bags on 7 February 2013, the highest since 2010.

According to trader Nedcoffee, Arabica coffee is reaching levels at which roasters would favor again the most expensive beans. Various roasters changed their preferences to use larger number of Robusta beans as the price of Arabica coffee reached to a new high on May 2011. According to the Macquarie Group, consumption of one of the most expensive beans decreased by 6.2% during 2011-12 season, which is ending on 30th September, whereas the consumption of Robusta usage increased by 11% during the similar period. According to Nedcoffee:

The real arbitrage, including differentials, is approaching levels, at which roasters could switch back to cheaper varieties of Arabica beans without influencing the cost price too much.

Differentials are defined as discount or a premium paid to obtain physical coffee in association to the futures price.

According to Kona Haque, an analyst at Macquarie, the demand of Arabica is expected to rebound by 1.5% to 75.2 million bags in the 2012-13 seasons that commenced on 1st October, whereas the demand for Robusta would grow by 1% to 62.5 million bags during the similar period.

Leaf Rust: A Catalyst for Lower Supply and Higher Prices

Central America's coffee farms may witness a 25% decline in exports in the next year as production declines due to a crop disease known as leaf rust or Roya. Roya is a disorder which was first discovered in Latin America in the 1970s. It is caused by the fungus Hemileia vastatrix, which attacks foliage and hampers photosynthesis. This deprives the coffee plant of energy and prevents beans from reaching full maturity.

In October, the situation became worse when the current year harvest commenced because coffee pickers carry the spores from the fungus on their clothes. According to Buitrago, lower prices could further reduce the spending on efforts to control the disease and replacement of the trees which are infected, as majority of the farmers as most of the farmers in the region harvest about 5 hectares of land or less and face financing problems.

According to Jose Angel Buitrago, the President of the Central American Organization of Coffee Exporters, in the next 12 months commencing from 1st October, approximately 3.45 million bags of coffee that could be exported would be lost from the 13.8 million expected in Costa Rica, Honduras, El Salvador, Guatemala, and Nicaragua. He also said that the disease spread at unprecedented rates due to irregular rains in August, followed by a comprehensive period of sunshine and high winds, creating perfect conditions for the disease to spread out across the country.

According to the International Coffee Organization, the combined shipments from the five Central American countries was about 13.65 million bags in 2012, representing approximately 12% of the world's total of 113.14 million.

Oddly, this blight has provided a little boost to the slumping prices.

Coffee Stock Valuation

Today's lower prices for coffee are not compelling enough to embrace the high prices of many coffee-brewing stocks:

Ticker

Company

P/E

P/S

P/B

P/FCF

EPS Growth Next 5 Years

DNKN

Dunkin' Brands Group

38.98

5.94

11.19

63.1

15.4%

GMCR

Green Mountain Coffee Roasters

20.99

1.8

3.2

24.25

18.9%

MCD

McDonald's

17.85

3.48

6.92

NA

8.9%

SBUX

Starbucks

29.5

3.01

7.95

47.59

18.6%

These high P/E and P/S ratios should be too bitter for investors who would like to play declining raw materials and higher gross margins in the short term.

Conclusion

There is currently a coffee glut and multi-year lows for a soft commodity. This will dissuade cultivation, creating long-term supply destruction. Supply will also weaken from Roya. Investors can play these factors by investing in ETNs with reasonable fees.

Please read the article disclaimer.

Source: Invest In Coffee And Ditch The Grind