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EYE ON COFFEE – PART III

Global Coffee Prices spun into a nose dive in the late 80’s after the collapse of the International Coffee Agreement. As major US household brands like Sara Lee and Kraft shifted rapidly to lower quality Robusta and other cheaper grades South East Asian producers began to ramp up production dramatically. Nowhere was this more pronounced than in Vietnam, which is among the largest global suppliers today after less than a decade of rapidly increasing export levels.

Prices for Vietnamese exporters have fallen dramatically over the past month, with the Vietnam Coffee and Cocoa association reporting average levels of $1,700 USD per metric ton vs. $2,500 in February. Anecdotal reports suggest that there has been a pronounced decrease in buyers from Western Europe and the US combined with a sudden collapse of credit facilities for local brokers and traders.

Vietnam’s presence as a low cost provider complicates the global coffee picture. Although they are primarily producing the less desired Robusta variety they have tremendous capacity and miniscule labor costs.

Andrew Barber
Director

EYE ON COFFEE - Part II

The report from the National Federation of Coffee Growers of Columbia cites an anticipated cyclical decrease in Brazilian production as Brazilian coffee fields enter the less productive second year of their two year grow cycle and an expected 2% increase in global consumption that they predict will cause a shortfall of as much as 10 million bags (down from an estimated 7 million bag surplus for this year). Put simply, Columbian growers are betting that the recent explosion in premium grade coffee consumption in markets like China will continue as the availability to consumers increases despite a weaker economic situation. This sounds like a decent assumption to us based on historical precedents –in periods of economic and political turmoil, coffee drinkers in western nations have proven to be resilient and resourceful, but we still view bullish reports from producer associations with a degree of suspicion.
  • Longer term, South American academics warn of potential production declines as rising fertilizer costs have seen independent farmers skimping in recent cycle. Agricultural experts say that the full consequences could be felt in crop yields in 2010 and 2011. In Brazil a report from the Cooperaiso coffee cooperative suggests that fertilizer sales are likely to fall by 20% over this crop year because of price levels, while the Columbian Government has earmarked subsidy funds to try and prevent declines in use by farmers there.
  • Andrew Barber
    Director

EYE ON COFFEE

Traders love coffee. Lloyd’s coffee house was a gathering place for speculators in shipping insurance and commodities in 18th century London that turned into Lloyd’s of London (the saloon across the street, Jonathan’s, became the London Stock Exchange –traders also love alcohol).

A data point on coffee this morning had traders taking note: the National Federation of Coffee Growers of Columbia is predicting a cyclical decline in Brazilian Coffee production will cause a global deficit as supply falls below demand that has grown dramatically in recent years.

  • To put in context, the grade of coffee produced in South America is the premium Arabica grade. Starbucks and other retailers have re-introduced premium South American blends to new audiences from the less urban parts of the US to developing Asian and Eastern European markets in recent years and Columbian Growers are betting that despite slowing growth one of the last sacrifices that people in those markets will make is their premium coffee in the morning.
  • Coffee Futures felt the same pressure as other softs in recent months as the great deleveraging process saw a tremendous amount of capital flow away from static log index investments which were based on rolling front month positions. Unlike Oil or Gold, Coffee does not enjoy the same following among institutional investors as a standalone investment and so the absence of index investors will significantly impact open interest and Volume. JO is an Ipath ETN based on the Dow Jones AIG Coffee sub index –which consists solely of front month NYMEX Coffee Futures on premium South American Arabica.
  • Andrew Barber
    Director

Early Look

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Chinese GDP Outlook: Are We Bullish Enough?

We continue to exhaust the bears with our new found bullishness on China. It would be hard to be as bearish as we were on Asia 9 months ago, so it's rather amusing to get this kind of feedback. Trust me, we get the bear case – we used to annoy everyone with it!

Below is a 3 year chart of Chinese GDP. Notice the seasonal pickup in the January period for each of the last 2 years. It could very well happen again. Anything can...

We wrote this morning that we see a Chinese recovery in 6-9 months. We question all of our positions, all day, every day... the question on this seasonality point is, are we bullish enough?

KM

MCD –TRENDS ARE SLOWING

There are a number of reasons to believe that MCD’s domestic business is slowing. First, a recent franchise survey estimates that MCD’s U.S. September same-store sales have slowed to 3.1% from August’s 4.5% number. According to the survey, the October number slowed even further. On a 2-year basis, this slowdown is even more apparent with 2-year average trends falling to 3.3% in September from 6.0% in August.

  • Second, the most recent data from WMT signaled that its sales trends have slowed. We have not heard from MCD since WMT reported its sales for September.
  • Third, we have posted in the past that MCD is getting more aggressive with coupons, which is another sign that MCD is struggling to generate traffic trends!

  • Fourth, we recently posted some data on industry discounting (please refer to my October 18 post titled “Deal or No Deal”). The data pointed to a significant increase in discounting. The combination of slowing sales trends and increased discounting will lead to lower levels of profitability.

  • Fifth, nobody is immune!

  • There are a number of reasons to be bullish on MCD, but I’m not in that camp. I have posted about franchise anxiety, which is at levels we have not seen in years. The currency benefit the company has enjoyed for the past years slowed significantly in 3Q08 and will be a drag to EPS in 4Q08. The bulls point to the new coffee program as being the savior for top line sales over the next 18-months. I believe that there are clear signs that MCD will need to adjust expectations down for that program as we enter 2009.

    One of the biggest issues for the stock is that the street is hiding in MCD as a “safe haven.”



DON’T WORRY HELP IS ON THE WAY

Sorry but I’m just not comforted by the United Nations announcement that its tourism arm is creating a Resilience Committee to combat the travel downturn. If you think the UN will be productive in this arena, buy Las Vegas. I’m not.

This is the same group that was very publicly positive on global tourism as recently as April. At the same time my partner, Keith McCullough was taking the exact opposite macro view.


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