Nestle Shares Reflect Global Demand For Cocoa

Summary

• A bullish trend in NSRGY and cocoa for two decades.
• Cocoa breaks out to the upside.
• NSRGY falls with stocks.
• Cost of goods sold could impact short-term earnings.
• The prospects for both looking sweet in the long term.

Nestlé S.A. (OTCPK:NSRGY), a Swiss food, and beverage company operates around the world. The company offers a wide range of products, but its name is often synonymous with chocolate. I remember an old advertisement for their products that was a jingle that went something like this: "N-E-S-T-L-E-S, Nestles spells the very best, chocolate."

The company has been around since way back in 1866, and with headquarters in Vevey, Switzerland, they are one of the world's leading consumers of cocoa beans. Nestlé is also a significant buyer of many other agricultural commodities required to produce their food products.

Since the turn of the century, both the price of NSRGY and cocoa have moved to the upside. Population and wealth around the world have grown, which increases the demand for food. Each quarter there are approximately twenty million more people on the earth competing for finite agricultural crops, and that has increased increase the demand for both chocolate and the products that Nestlé offers the world.

A bullish trend in NSRGY and cocoa for two decades

These days, the price of cocoa beans and Nestle stock are both significantly higher than they were back in 2000.

Source: CQG

As the monthly chart of ICE cocoa futures highlights, in February 2000, the price of cocoa beans was trading at the $750 per ton level.

Source: Barchart

At the same time, NSRGY shares were at the $17.20 per share level. On Tuesday, March 6, nearby ICE cocoa futures were trading at $2441 per ton, over three times the price in early 2000, while NSRY shares were at the $79.65 level, over four and one-half times higher than the price at the turn of the century. Demographics has boosted the demand for the primary ingredient in chocolate, and for Nestlé's products.

Cocoa breaks out to the upside

Over recent sessions, the price of cocoa beans has broken out to the upside after a long period of consolidation.

Source: CQG

As the weekly chart shows, the price of ICE cocoa bean futures fell from highs of $3422 per ton in December 2015 to lows of $1769 per ton in June 2017. Bumper crops from the West African nations of the Ivory Coast and Ghana, the two countries that produce more than 60% of world supplies, caused the swoon in the price of the agricultural commodity. Since the lows last June, cocoa had traded in a range from just under $1800 per ton to highs of $2236, but on March 1, the price moved above the top end of the consolidation range and to highs of over $2450 per ton on March 6. The price is now at the highest level since November 2016, and that could have significant ramifications for companies, like Nestlé that are consumers of the commodity.

NSRGY falls with stocks

While cocoa has been rising over recent sessions, NSRGY stock has been going the other way.

Source: Barchart

As the chart of NSRGY stock shows, after trading at a high of $89.40 per share in June 2017, the stock has moved lower and was at the $79.65 level on March 6. It is likely that the rise in the price of cocoa (and other agricultural commodities) is weighing on the price of Nestlé's shares, and the company may not be alone. Cocoa and other agricultural products are the inputs in the production of the goods these firms sell to the consumer market.

Cost of goods sold could impact short-term earnings

The price of cocoa, grains, soft commodities, and meats, are the primary input when it comes to processing the foods that companies like Nestlé sells to people all over the world. When prices for the inputs move to the upside, the cost of goods sold for these companies rise. Unless they increase prices, their profit margins move lower, and the pressure of increasing prices begin to weigh on earnings. Eventually, these companies will raise their prices and individual consumers will pay for the higher raw materials, but there could be a time lag when it comes to profit margins for the companies.

Over recent years, weather conditions around the world have resulted in bumper crops and stable prices for agricultural commodities. Consumers, like Nestlé, have seen prices slip, so they backed away from hedging price exposure. Purchasing managers at these firms faced the prospects of decreasing prices, so they were hesitant to lock-in prices under the fear of criticism if they wound up buying at higher levels than the current market price for the raw materials. However, when prices turn, large consumers often find themselves chasing prices higher without the ability to increase prices immediately causing their profit margins to suffer in the short-term. Price stability offers significant consumers the best environment to make money, and the current financial climate could be changing for these companies.

While cocoa broke to the upside over recent trading sessions, grain prices have also been moving higher. Cocoa's ascent could be the result of weather conditions that are impacting the cocoa crop in Ghana. Dry conditions in Argentina have caused the price of soybeans and corn to move higher over recent weeks. When it comes to wheat, the price of the staple commodity that is the primary ingredient in the production of bread has moved back over the $5 per bushel level over recent days as a lack of snow cover on the winter wheat crop in the United States damaged some of the crops. The bottom line is that a rise in many agricultural commodities over recent weeks will weigh on the profits for manufacturing companies like Nestlé and many others around the world who have been procuring their requirements on a hand-to-mouth basis rather than hedging over recent years.

The prospects for both looking sweet in the long term

The price of cocoa has moved higher and broke through its technical resistance level. A 50% retracement of the move from the December 2015 high to the June 2017 low could take the price of the primary ingredient in chocolate to the $2600 per ton level. Meanwhile, a continuation of a rally in cocoa, grains, and other agricultural products will likely mean that we will be paying higher prices at the supermarket for food. When it comes to NSRGY stock, technical support is around the $66 per share level which was the November 2016 and October 2014 lows. However, it will not be long before Nestlé, and the other food giants around the world will adjust their prices and profit margins will improve.

I will be a buyer of NSRGY stock at the $66 level, and when it comes to cocoa and other agricultural commodities, it is all about the weather conditions these days. The past years of bumper crops could be coming to an end which would light a bullish fuse under many agricultural markets and fan inflationary flames that are already rising over recent months. Demographics have pointed to the rising demand for food around the globe even as corps were at bumper levels. If shortages develop, we could be at the beginning of a period of explosive price action in many of these agricultural commodities.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.