Coffee As An Investment: Where to Allocate Capital in a Record-Setting Coffee Market

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Global coffee prices have surged 55% throughout 2021. The global coffee supply chain in general is being tested in a manner that hasn’t been commonplace in the past.  We are seeing areas of the coffee value chain that are absorbing a tremendous amount of the total value created in the sector while other market participants are being squeezed out to the point of potential bankruptcy.  Where is the opportunity as an investor in the coffee sector?

Source

Coffee Prices Should Stay Elevated in the Near-Term
The largest factor in the global coffee pricing game revolves around what is going to happen to Brazilian coffee production both this year and in the future. As Brazil makes up roughly 40% of the world’s total production of coffee, their swings in production matter more than any other market.  In recent years, their weather patterns have been unpredictable and negative to coffee production within the country.  This year, we have seen droughts and frosts that have devastated certain coffee growing regions within the country, causing significant decreases in the country’s annual production. In a recent Reuters article, Brazil’s September 2021 green coffee exports were down 29% as compared to the same period last year. Certain studies have been completed which suggest that the events of weather patterns this year are not temporary.  The effects of climate change are going to have a negative impact on Brazil’s coffee production indefinitely into the future.  As a result of these expected production issues within the world’s largest coffee supplier, certain experts are forecasting coffee prices to potentially hit $3.00 per pound, a win for those coffee producers outside of Brazil who are able to grow and deliver coffee.

Coffee´s Supply Chain Participants

These drastic price increases in coffee have caused a chain reaction that is devastating to some coffee market participants, but incredibly lucrative for others. Simply stated, from farm-to-cup, the global coffee supply chain consists of the following participants:

  • Farmers/Producers: Those who grow the coffee
  • Coffee Buyers/Coffee Exporters: Those who buy the coffee from the farmers/producers
  • Coffee Importers: Those who import coffee into regions where coffee is not naturally produced
  • Coffee Roasters: Those who transform the coffee bean to its ground, usable form 
  • Coffee Retailers: Those from whom you purchase your coffee (e.g., cafes, grocers) 

Why are some market participants now benefiting while others are not?  If coffee prices are at record highs, shouldn’t everyone be winning?

Single-Origin Coffee Producers Now Lead the Market

In this market, of all the participants in the coffee supply chain, only coffee producers can control their own destiny. This is what we are seeing on-the-ground in our portfolio company, the Green Coffee Company, a market leader, and Top-3 producer in the Colombian coffee market. 

  • Colombian farmers/producers are not delivering their crops to middlemen. They prefer to speculate on potentially higher future pricing:  Colombian coffee producers have failed to deliver up to 1 million bags of coffee beans this year, almost 10% of Colombia’s total crop to-date. This decision has been deliberate. Producers are betting that prices will continue to rise and prefer to wait-and-see on pricing movements. Due to the price increases seen during the year, many coffee farmers are simply processing their coffee and waiting to see what happens on the international coffee markets. Coffee can stay reasonably fresh for months if stored and packaged correctly, so the urgency of producers to sell is limited. We believe it is reasonable to assume that this speculation activity will continue throughout 2021. Failing to deliver is likely to create havoc on the coffee intermediaries in the supply chain, such as exporters, traders and roasters that rely on consistent trading activity. Value in the coffee industry will grow where consolidation is possible – companies that can supply and deliver their own coffee down the value

  • With a lack of coffee to sell, coffee exporters and importers are defaulting on their international contracts with large coffee buyers: Nearly all coffee intermediaries, businesses like traders and exporters, rely on constant supplies of coffee in order to stay in business. With some coffee farmers in Colombia and elsewhere willing to break physical trade contracts in order to speculate on a potentially higher future trade price, traders face massive issues as they are unable to fulfill their own contracts in international markets. Many international market contracts have steep default clauses, the kinds of which can bankrupt a company if they don’t fulfill a material number of their contracts.

  • As coffee becomes more scarce for coffee intermediaries, they are sourcing coffee from various producers and mixing the product, creating a correlating premium on single-origin coffees:  Single-origin coffees have always been popular with the premium coffee buying segment.  As the coffee all comes from one geographic area, the implied flavor profile of single-origin coffee is expected to be more consistent and homogeneous than a geographically-dispersed blend.  This year, we are seeing that coffee intermediaries are blending a huge portion of their coffees, even if they aren’t telling their customers they are doing so. True single-origin coffees are becoming more valuable within the 2021 vintage.

What do we expect to see in the near future in coffee markets?

  • There will probably be a string of debt defaults in the coffee intermediary space, with bankruptcies likely to occur: For companies who are completely reliant on buying coffee from producers at fixed future pricing and re-selling to an international buyer at higher fixed future pricing, their business models are essentially devastated as of this year’s upward price movements.  By trading on fixed pricing and having delivery defaults occur at the domestic level while producers await higher commodity pricing, these coffee intermediaries are going to stretch their existing capital balances to either cover their physical trade losses or will have to go bankrupt in the process.  We believe it is highly likely that several trading houses and local cooperatives, who lack the appropriate capital reserves (i.e. the smaller players), will default on their existing debt holdings in the near-term. As we explore acquisition opportunities at the Green Coffee Company, we have talked to several banks that are already seeing debt distress with certain of their existing coffee-intermediary clients and are expecting restructuring negotiations to commence in the near-term. For intelligent operators, certain acquisition scenarios may present themselves over the next several quarters.

  • Coffee producers who can provide single-origin coffees and control the supply chain will benefit greatly from current trends:  As supply wanes in Brazil, coffee producers with coffee and the ability to fill the gaps in the supply chain control coffee pricing and output. We expect that when we allocate the effects of intermediary distress noted above that certain coffee producers will outsizingly benefit.  There will be potential consolidation in the market as smaller intermediaries are squeezed out, acquired or fall into bankruptcy.  Single-origin coffees will become more scarce, providing even more leverage to intelligent trading operations to increase their existing premiums over international commodity pricing present on international exchanges.  Larger producers who can provide single-origin, farm-direct coffees and are not in need of intermediary companies to sell their product in the international coffee markets will be rewarded greatly.

Conclusion

Coffee markets continue to garner more attention from investment capital.  It is important to understand market trends and how each portion of the coffee supply chain is being impacted when deciding where to enter the market as an investor.  If coffee is a market that you want investment exposure to, then we believe that the best options for investment are in those businesses that are not reliant on others for supply and that can fill the void as market dynamics force some participants in the coffee supply chain to exit.   

About Legacy Group

Legacy Group is distinguished by a singular tradition of service to our portfolio partners; the mutual commitment to, and the seamless collaboration of, a true partnership; formidable financial and legal talent across multiple disciplines and jurisdictions; and shared professional values that focus on client needs.

We provide experience and investment to a wide range of private companies spanning many industries, including real estate, hospitality, tourism, agriculture and technology. Contact us to learn more and to discuss current investment opportunities available to you in our portfolio companies.

*This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer. Any views expressed herein are those of the author(s) and not necessarily those of our clients.

Sources:

https://www.reuters.com/world/americas/exclusive-major-coffee-buyers-face-losses-colombia-farmers-fail-deliver-2021-10-11/?fbclid=IwAR3pYxXKM6WoSUCyRvFlZuhZINXAiXN3hv4-X2VrxGIQ9DwfcNImN3gQvEc

https://www.pri.org/stories/2021-09-10/drought-frost-takes-massive-toll-coffee-crops-brazil

https://gcc-coffee.com/

https://tradingeconomics.com/commodity/coffee

https://www.reuters.com/world/americas/brazil-coffee-exports-fall-29-sept-shipping-hurdles-2021-10-13/

https://daily coffee news.com/2020/10/23/how-climate change-may-already-be-affecting-brazils-2021-crop

https://sipcoffeehouse.com/coffee-producing-countries