Our horizontal integrated business structure combined with our hedging policies helped us to significantly alleviate these higher costs as evidenced by our cost of sales only slightly increasing by 0.02 % during a time when the underlying commodity increased by over one dollar per pound as the fundamentals in the coffee market led to higher futures prices.
This past Thursday, Coffee Holding Co., Inc. (NASDAQ:JVA) published results for its first operating quarter of 2011. For the period ended January 31, net sales were up 20% compared to the same period in 2010. However, in the two trading sessions that followed the financial report, shares rose 74% to the tune of shrewdly overvalued.
In the press release accompanying financial results for the most recent quarter, the company wrote: "The increase in net income primarily reflects increased gross profit." True. If overhead costs remained stable, and sales grew, then the contributing factor would have to be gross profit.
This piqued one inquirer's interest, in that it implied gross margins remained stable. But the company itself concluded in the very same press release that "commodity pressure" and "dramatically increased coffee prices" placed a burden on its business. This would imply shrinking margins.
This hedging policy, disclosed in its 10Q filing with the SEC, shows that speculation in the futures market led to a favorable gross margin. The slight 0.02% increase in the cost of sales was, therefore, attributable to a one-time gain on futures contracts. Here's a detailed look at the disclosure.
For the three months ended January 31, 2011 gains totaled $680,000 versus $135,000 in the comparable period of 2010 (see above schedule). That $545,000 contribution made up the difference in bottom line earnings from one period to the next.
Herein lie two key points. The first is that an improved bottom line in the most recent quarter is not the result of growing or otherwise enhanced operations: "The increase in net sales reflects higher sales prices compared to the first quarter of fiscal 2010 ...."
As input prices increased, the company was forced to increase the price at which it distributes its products. While the nominal numbers impressed investors, the 20% jump in net sales does not necessarily mean that "quantity sold" increased substantially. In fact, by the numbers, it's difficult to point out any material change from last year.
Further, excluding the one-time gain from futures speculation, gross margins were depressed when compared with the same period in 2010. And income adjusted for this event would contribute approximately the same earnings per share as in 2010. Therefore the ecstatic reaction in the stock's market was unjustified.
The second point is that market prices fluctuate, for everything from commodities to equities to currency. So to expect gains from futures contracts to rescue the company's shrinking margins quarter after quarter is a dangerous assumption. Markets are uncontrollable, which exposes the company to potential losses on its derivative bets. In all likelihood, Coffee Holding Co.'s overvaluation was the result of investors assuming uncertain (but favorable) events without factoring in potential risks in this business.
If not the numbers, then what led to the surge in stock price and trading volume? Deja-vu market speculators. So ask yourself: What if other investors realize Coffee Holding Co. isn't the growth story they sought? And suppose that next quarter, earnings came in flat instead of improving over last year’s. Would that justify the stock price sliding back down to $4/share?
Beyond a reasonable doubt, Coffee Holding Co., Inc. is overvalued at its current market price.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in JVA over the next 72 hours.
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