- Address the concern regarding CEO Gordon's selling of some of his shares.
- State the case that coffee is poised to continue up in price and JVA is a good way to play the rise.
- Talk a bit about the rising coffee price and why JVA may benefit.
Back on March 4th I penned an article titled, "That's Some Lava Java", in which I made the case why I thought buying Coffee Holding Co. (NASDAQ:JVA) was a good way to play the rise in coffee. I still believe that JVA has a lot going for it, but investors are expecting too much too soon. JVA is not coffee in the same way that gold mining stocks are not gold; they don't track the commodity price in sync all the time while dramatically outperforming at other times. At the moment JVA is consolidating its gains as the coffee price continues its rise, at some point JVA will join the party.
After JVA's earnings came out, its shares shot up to a high of $8.58 on March 18th and have subsequently traded back down to fill in the gap left by the announcement. Shortly after the shares' dramatic run, coffee futures began a plunge from over $210 to about $169, with a report from MDA Forecasting that rain would fall in Brazil thereby saving the growing season. I am not sure where the MDA Forecasters got their information, or for what purpose, but through the miracle of the internet I was able to track radar of rainfall in Brazil and see that they were incorrect. Even if they were correct, growing living things is not like making a widget; just because the rain arrives, it is not like flipping a switch to ramp up production. A drought like Brazil has faced takes an entire season to overcome affecting the following year's crop as well. Now the latest reports coming out are showing that the victory dive in coffee prices was apparently premature as the rains now will be overwhelming as an El Nino is forming. The situation seems to be going from bad to worse, which could be very beneficial for coffee suppliers that have inventory, a pipeline to more beans and are able to hedge. The net result is that coffee futures have rebounded smartly to the upside and are $212.70 as I pen this tome awaiting more confirmation - crop reports are due in May a couple weeks from now.
In the meantime, I want to address a couple issues that have popped up regarding JVA. The first item is the insider selling of shares by Andrew Gordon, the CEO of Coffee Holding. I took it upon myself to contact Mr. Gordon, who graciously answered my questions. Regarding his 105B-1 planned sale he had the following to say: "Diversification was the sole reason for sales, not my view of future company performance. Also, I did cancel the plan rather than sell additional shares at this time." Furthermore, it should be noted that while Mr. Gordon did sell 124,198 shares, he still holds 216,183 shares which is around $1.6 million of skin in the game. Moreover, it should be noted that Andrew's brother David Gordon, who has access to the same internal information, did not register or sell a single share of his 363,185 shares roughly $2.5 million of equity (at today's prices).
The next topic is the concept that some of JVA's earnings were derived from hedging. In the last earnings report with coffee trading at multi-year lows of roughly at $1.20 a pound, the company was still able to earn $.22 per share - not too shabby. It appears that $.10 of those earnings were attributable to hedging strategies and there are those that complain about that. There is no way to make all people happy all the time. When coffee was declining into the multi-year low, the Gordon brothers were on the wrong side of the hedge and it cost them and shareholders; yet when they right the ship and are correct they are criticized. Realistically, when your business involves a commodity that can have price swings it is only prudent to have some hedges to help normalize earnings. In my communication with Mr. Gordon he pointed out that hedges are needed to help minimize risks. He went further stating: "Disclosures to say we have problems when (coffee) prices fall quickly but tend to benefit in times of rising prices (or at least market stability)."
Another area of concern for investors appears to be the idea that rising coffee prices are going to hurt JVA, but between hedging and inventories purchased at lower prices there is at least a modicum of protection. Looking at the latest 10-K for JVA the company was carrying almost $9 million in inventory which we know was acquired before coffee started its rise so it was likely purchased well below the $2 mark. The company also was showing another $620 thousand of prepaid green beans yet to be roasted in the pipeline. This lower cost inventory will end up going to JVA's bottom line in the future as the margin has expanded due to the rise in coffee.
Changing gears a bit, I then asked Mr Gordon, "In the past, Coffee Holdings has relied on long-term relationships for both procurement and sales of beans\coffee, but with the changes in the market is the company looking to move to more contractual-based relationships?" His answer was short and to the point simply replying, "We currently do both".
As a follow up I pose the following: "Between inventory of beans that was disclosed in the 10K and current agreements that Coffee Holdings has in place with favored suppliers do you feel that the company will be able to contain costs in a rising price environment as not to shrink margins for an extended period as the drought and El Nino play out?"
Gordon responded, "This information will come out in our next Q2 report." The question may have been a little to close to non-public information at this time but at least we should have answers to that question during earnings.
I noticed that the DTS8 Coffee Company, mentioned in my prior article as one of the methods through which Coffee Holdings is looking to diversify their customer base beyond the key customer dependency with Green Mountain Coffee Roasters (NASDAQ:GMCR), was profiled by S&P Capital IQ Factual Reports on April 21, 2014. DTS8 Coffee Company has the exclusive license to roast and sell JVA coffee using their premium brands like Don Manuel into most of Asia. The fact that they made S&P's radar could be indicative of the company making inroads in the Asian market, which dovetail's nicely into JVA's growth and diversification plans. I did query Mr. Gordon with regards to this development, but he was unable to comment at this time because it was not public information.
The conclusions I draw are that JVA will continue to do very well as long as coffee prices are moving up or stable. One also has to remember that JVA sells the commodity, but is not the commodity, therefore it will not necessarily jump the same day as coffee does nor will it necessarily fall if coffee pulls back. JVA will trade on its own timetable and is subject to the mentality of equity players who tend to have a different mindset than an individual who might be purchasing commodities.
I believe that the Gordons have a handle on the business and are making the right moves to address the problems that plagued them over the past couple years. Some of those problems were in their control, some were not such as falling coffee prices. I believe that the Gordons have righted the ship and everything from coffee price to weather affecting coffee harvest will push JVA stock up over the coming months. Please remember that companies with a market cap this size can be volatile, especially given the limited number of shares and small float, so it is not for the faint of heart. All one has to do is look back at the performance of JVA the last time coffee peaked out at about $2.50 a pound the shares rocketed to $35 each.
Assuming coffee keeps going up as I believe it will due to Mother Nature, JVA's earnings will continue to grow and demand for its shares will drive the price higher than most expect, then you will see what they mean by Jumpin' Java!
Disclosure: I am long JVA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I did converse with Mr. Gordon the CEO but I did not receive any proprietary insider information only clarifications. I have no relationship with JVA or Mr Gordon other than being a shareholder in the company. All information other than quotes from Mr. Gordon are either readily accessible on the internet or hyperlinked. The views and analysis are my own and I am long the shares.
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