Everyone who roasts, buys, sells, wholesales, pours or grinds coffee needs to have an understanding of the factors that drive the commodity price for coffee. I have posted several times on my predictions for the price of coffee by the end of the year, and the factors that will make those predictions happen. As I type, the "C" has appreciated approximately 18% since the credit downgrade of US debt, and the realization that the likelihood of another recession is increasing. European sovereign debt issues and the search for safe havens for capital have contributed to the appreciation of the commodity price for coffee. These factors were all identified in my earlier posts as game changers for the price to move down, but fear not, what goes up, goes down again. It is with this in mind that I wanted to start a series dedicated to profiting from the volatility of the coffee market, focusing on Options Trading. The reason I want to focus on Options Contracts rather than futures contracts, is that there is much less risk associated with Options, and no need to employ leverage. Options contracts are also very useful when there is a lot of volatility in the underlying commodity. Coffee has been a very volatile market for the past two years, and promises to continue for the foreseeable future. The upside of a well executed options contract is nearly unlimited, but the downside is limited to the purchase price of the Options Contract, therefore you'll never receive a margin call.
Coffee Options are contracts written based on the commodity price of coffee and whose price is derived from the underlying value of the market price. This type of instrument is a derivative.
There are two different types of options, Calls and Puts. And understanding of these terms is crucial to participating in Options trading.
Option Owner Rights:
Call Option holder has the right, but not the obligation, to purchase a specific number of future contracts at a set price (strike price).
Put Option holder have the right to sell, but not the obligation, to sell a specific number of future contracts at a set price (strike price).
Option Seller Rights:
Call Option holder has the obligation to sell a specific number of future contracts at a set price (strike price).
Put Option holders have the obligation to buy a specific number of future contracts at a set price (strike price).
*Selling a Call Option (Put Option) on a Contract you don't own (Naked Call/Put) obligates you to sell at predetermined price and exposes you to unlimited loses if the Commodity Price increases (decreases). Example: Selling a Naked Call Option with a strike price of $2.39, and the commodity price moves quickly to $2.70, you are obligated to sell a contract for $2.39 when you are forced to purchase the contract to cover at $2.70 resulting in approximately $11,000 loss on a single contract. This effectively saddles the Seller with the same downside potential as if you were shorting the contract.
The important thing to remember is that Option Sellers have obligations, Option Purchasers have Rights, but not obligations.
I would recommend purchasing Options rather than Selling (Creating) Contracts. Purchasing Options requires less investment, less downside, with equal upside.
If you expect the price of coffee to increase over the course of time that the contract is valid, you would purchase a Call Option, which becomes more valuable as the price increases.
If you expect the price of coffee to decrease of the course of time that the contract is valid, you would purchase a Put Option, which becomes more valuable as the price decreases.
Options expiration dates occur on the Saturday following the third Friday of each month, which effectively means you have until the third Friday to exercise your rights. I would not recommend trading out of a contract on the last day before expiration as the value of an options contract reduces as it approaches expiration. Exiting an Options Contract is as simple as calling your broker and supplying them with instructions to sell your Option, or exercise your rights.
What I've covered in this post is by no means sufficient to arm you with trading skills, but try to grasp and understand these terms and definitions and we'll expand the topic in a comprehensive way over the next few posts. Next time I'll cover identifying strike prices and costing break even points for Options Contracts using current market prices, and follow some hypothetical trades in real time.
Thursday, August 25, 2011
Friday, August 12, 2011
New Location Design Exercise
It's been a little while since I posted last. This is not due to any lack of interest or subject matter, but a family illness that has almost completely consumed my mental attention.
Rest assured I have a cranium filled with relevant topics that I hope will benefit anyone out there interested in starting their own coffee shop.
What I've decided to do is to let all of you in on the exact details involved in the design and build out of my company's new location. The space was chosen after many failed attempts at securing lease that met the following criteria:
1. Affordable Rent
2. Minimum 10 years term
3. Geographically removed from our existing locations so as not to cannibalize sales
4. Located in what is to referred to as "downtown" in my city
5. A corner or equivalent location of high visibility and traffic
6. Existing interior features that would be attractive to customers
7. The possibility of fully operational windows to permit an indoor/outdoor feeling
8. A reputable landlord who cares for their buildings and chooses their tenants carefully
9. Minimum 800 square feet, maximum 1500 square feet.
10. Suitable masthead to accomodate visible outdoor signage
The space we chose is directly across from the oldest continually operating outdoor market in Canada, which serves as an outdoor skating rink in the winter. The square is also home to antique markets, concerts, outdoor movie nights, buskers, water fountain, Christmas tree in Winter and city provided free cafe tables. It is one block from the waterfront, and directly behind our historic City Hall which served as Canada's first capital. The location is not a corner, but the open space across the street permits broad visibility and prominence.
In addition to these features, the interior space has 14' ceilings, exposed brick on one wall, and exposed limestone on the other. The front of the building will be re-pointed this fall, and new operational windows and doors installed that meet strict historical standards enforced in our city.
I have included a JPEG of the layout of the raw space listed as "322" on the drawing, and am encouraging readers to copy the image and sketch out their own versions of what they think the space should look like. Each attempt should include 2 washrooms, seating for at least 20, a service counter (cash and espresso bar). The dividing wall between 318 and 322 is exposed red brick, and the angled wall is exposed limestone. The front windows swing in to open.
Have fun and please respond with your designs in the comments. Don't worry about doing anything overly technical, just draw on it, scan it, and submit it. I hope some of the submissions will spark interesting debate, and will ultimately end up in the finished drawings. As we progress I will produce an equipment list, and budget that will adhere as close to possible to my 50 Grand Business Plan. Impossible you say! Well let's see.
Tuesday, May 31, 2011
Structuring the Sale of a Company
I wanted to create a quick and timely post to fill in some blanks about how a company might structure an investment from say, a Private Equity Fund. Reading my description of a Balance Sheet may help.
First, let's assume that if you are large enough to attract the attention of a PE Fund, then you are already Incorporated with an existing Share Structure. This Share Structure typically has two classes of shares, Common and Preferred. Common Shares are voting shares and usually where the value of a company is reflected as price per share.
Preferred Shares are non voting shares, but in some instances (especially involving outside investors) can contain all of the company value in the form of asset backed interest bearing shares that must be paid before any dividends are paid to common shareholders.
If a PE Fund wanted to invest in an existing incorporated coffee company, they would set up a separate corporation with a common share structure that reflects the final ownership percentage. The fixed assets of the original corporation would be held within this company as security to offset the cash investment of the PE. For example, if the ownership is 50/50, and the value of the company is determined to be $1,000,000 and the PE fund wanted to invest a further $1,000,000 , the common shares would be split 50/50, and the preferred shares would be set up so the cash infusion of $1,000,000 would be offset by a balance sheet entry of equal Preferred Share Value, and the Fixed Assets brought into the new corporation would also be offset by $1,000,000 balance sheet entry of Preferred Shares.
If the PE fund wanted to invest more than the value of the company, but the existing owner didn't want to give up more than 50% ownership, the common shares could still be distributed 50/50, but the PE fund could have more (even all) Preferred Shares. The value of the Preferred Shares would be secured by the balance sheet assets and a Shareholder Agreement drawn up to protect the investment by precluding dividends until Preferred Shares are converted to Treasury Shares or retired. The original owner could also completely cash out the value of the original company balance sheet by selling the assets to the PE fund, and the transaction reflected by placing the whole value in Preferred Shares owned by the PE fund. The common shares could still be distributed 50/50. In this instance, the PE fund may also have provisions written into a Shareholder Agreement that would permit the conversion of Preferred Shares into Common Shares if some "triggering" event should occur. Last, some investors may look to have a "shotgun" clause written into a deal which permits either party to submit an offer to purchase the other party's shares which must either be acted upon, or the recipient of the offer becomes compelled to purchase the other party's shares under the same terms that were offered.
Believe me, the Devil in any deal is in the details. No matter what anyone says, only the parties involved actually would know how any deal is structured, but more often than not, the stroke of a pen leads to unintended consequences.
First, let's assume that if you are large enough to attract the attention of a PE Fund, then you are already Incorporated with an existing Share Structure. This Share Structure typically has two classes of shares, Common and Preferred. Common Shares are voting shares and usually where the value of a company is reflected as price per share.
Preferred Shares are non voting shares, but in some instances (especially involving outside investors) can contain all of the company value in the form of asset backed interest bearing shares that must be paid before any dividends are paid to common shareholders.
If a PE Fund wanted to invest in an existing incorporated coffee company, they would set up a separate corporation with a common share structure that reflects the final ownership percentage. The fixed assets of the original corporation would be held within this company as security to offset the cash investment of the PE. For example, if the ownership is 50/50, and the value of the company is determined to be $1,000,000 and the PE fund wanted to invest a further $1,000,000 , the common shares would be split 50/50, and the preferred shares would be set up so the cash infusion of $1,000,000 would be offset by a balance sheet entry of equal Preferred Share Value, and the Fixed Assets brought into the new corporation would also be offset by $1,000,000 balance sheet entry of Preferred Shares.
If the PE fund wanted to invest more than the value of the company, but the existing owner didn't want to give up more than 50% ownership, the common shares could still be distributed 50/50, but the PE fund could have more (even all) Preferred Shares. The value of the Preferred Shares would be secured by the balance sheet assets and a Shareholder Agreement drawn up to protect the investment by precluding dividends until Preferred Shares are converted to Treasury Shares or retired. The original owner could also completely cash out the value of the original company balance sheet by selling the assets to the PE fund, and the transaction reflected by placing the whole value in Preferred Shares owned by the PE fund. The common shares could still be distributed 50/50. In this instance, the PE fund may also have provisions written into a Shareholder Agreement that would permit the conversion of Preferred Shares into Common Shares if some "triggering" event should occur. Last, some investors may look to have a "shotgun" clause written into a deal which permits either party to submit an offer to purchase the other party's shares which must either be acted upon, or the recipient of the offer becomes compelled to purchase the other party's shares under the same terms that were offered.
Believe me, the Devil in any deal is in the details. No matter what anyone says, only the parties involved actually would know how any deal is structured, but more often than not, the stroke of a pen leads to unintended consequences.
Wednesday, May 25, 2011
10 Questions With BGA Chair Jason Dominy
Coffee Kings: You are very active in all areas of social networking and are a dogged promoter of Batdorf and Bronson, the BGA and manual brewing in and around the Atlanta area. To some it might seem that coffee IS your life. I know there’s a lot more to you than work. Tell me about the things in your life (family/friends/hobbies) that make working long hours easier.
Jason: I have to say that spending time with my wife is my favorite thing, and I mean that. She's really my best friend, and hanging out with her doing anything is pleasurable. I also own a MINI Cooper S, and we love taking rides in it, especially in the mountains on the curviest of roads, as fast as we can. We are members of a local MINI club, and do drives and scavenger hunts with them frequently. I also love playing disc golf, and do it every chance I get.
Coffee Kings: You’ve distinguished yourself among your peers for your skills, work ethic, knowledge and welcoming manner. Those are all skills that make not only great employees but also excellent owners. Do you have any aspirations for owning your own shop one day?
Jason: I started off in coffee by opening two coffee shops. I remember the amount of stress and challenges that came along with that, and I'm not interested in getting back into from that perspective. One of the great things about my position now, is that I take all of my coffee experience over the past 14 years, and use it to help others opening coffee businesses. Each one is a project with great consequences, so I take pride in helping them as best I can be successful in their coffee business utilizing the things I would be putting into practice as a shop owner myself.
Coffee Kings: I’ve been a little critical and skeptical about manual brewing, something you are deeply passionate about. Tell me about your participation in the US Brewers Cup Championship and whether you think it can achieve what the Barista Championships has relative to improving the quality of the products served across the industry.
Jason: I am a huge proponent of manual brewing for several reasons. One, I love the fact it brings back a level of focus and communication between the barista and the customer. Second, I love the taste of properly manually brewed coffee. Third, It's easy to do, and allows you to brew lots of different coffees quickly. I think currently there is alot more bad manually brewed coffee than there is good, but I know that you could say the same for espresso. And all we can do as coffee professionals is train as many fellow baristas as we can as how to properly brew it, and how extraction works.
As far as the Brewers Cup, I think it's a good start. I had some issues with how it went down in Houston in terms of judges calibration, but this was their first year, and for the first year, I thought it was done well. It's definitely a great launching point for a competition that could be really cool to see. I'm all about seeing baristas pushing each other to brew better coffee. I really do think it will encourage baristas to learn to brew better coffee. I think the challenge is that baristas don't understand exactly what the judges are looking for in a cup of coffee, what a Q grader is looking for. I know it will get better, and the organizers will take a look at what went well, and what needed improvements and make positive changes.
Coffee Kings: I know you’ve conducted some research about the level of income baristas around the country are achieving. What do you hope to do with the results and what is your opinion of the barista income in the USA?
Jason: I wanted to show that baristas wages are relatively the same across the US, and baristas can improve their wages by investing in themselves. I believe that baristas don't make enough for what they do, what they put up with, and how much time they invest into themselves and their career.
Coffee Kings: One of the things I think is an obstacle to growing the BGA into an influential entity within the industry is an impression that unless you compete or intend on competing, there is nothing for you within the BGA. How do you address the concerns of working baristas and make them feel as valued as competitors.
Jason: I have never competed in a barista competition. I have no desire to compete in one. At one point, I was the only Executive Council member who was not either a US Barista Champion, or at least a Regional Champion. The BGA has always been for me a guild for all baristas, not simply ones who compete. I've never noticed a focus on competitors, it's just that most of our logos and branding shows up around competitions. I do not agree that if you're not a competitor there's no value for you. Because there has been for me in all my time as a BGA member, and being able to be more active in shaping the BGA, and now becoming the chair, proves that point. At Camp Pull-A-Shot, there were tons of great baristas who are not competitors, taking advantage of just one aspect of what the BGA has to offer. The BGA is for ALL baristas, and shows no favoritism.
Coffee Kings: I’ve noticed over the past 4-5 years especially that there appears to be a segmentation of coffee companies with several being promoted as either the best, freshest, most exclusive, highest quality, hippest etc, etc. I seems to me that most of the praise is focused on a few, where there are literally dozens achieving the same quality without recognition. Is this phenomena concerning to you? Tell me about one or two excellent companies who deserve more attention.
Jason: I will agree that historically, the roasters who speak the loudest get heard the most. I will also agree that there are tons of great roasters all around the country that don't get tons of attention. I blogged about this just today. I think roasters that should get more attention are PT's Coffee, Klatch Coffee, and Kaldi's Coffee.
Coffee Kings: What is the participation rate of BGA members in the election process? Do you think the rate of participation harms the ability of the BGA executive to move the association in new directions?
Jason: We had great participation in the past election, some of the best we've had. We also posted up a survey that allowed us to hear from the membership on a larger level, and we have taken all of the feedback to heart, and are acting on it. I feel like we totally understand what our members are looking for in the BGA, and are working as hard as we can as volunteers with full-time jobs and multiple other involvements in the industry, to make it happen.
Coffee Kings: As an international member I can vote for executive positions within the BGA but not regional representatives. Are there any plans to create a seat for international representatives on the executive board in the future?
Jason: We have spoken about an international BGA rep, and have been working on creating that position, who it would be, and what that would look like.
Coffee Kings: You’ve been supportive of the Coffee Common initiative held at the TED Conference in Palm Springs, something I’m less enthusiastic of. I see the Coffee Common as something dismissive and harmful to the SCAA, tell me where I’m wrong.
Jason: "The rising tide floats all boats."
Coffee Kings: If you could pick one thing that you hope to accomplish this year on behalf of the BGA membership, what would it be and how can we all help to make it happen?
Jason: The things I'm most passionate about are:
making sure that baristas all over feel valued and appreciated, no matter who they work for, or where they live.
I want to see the Certification thrive, and baristas and shop owners see the value in it.
I want to see us value and appreciate all the work that has been done before us on the BGA, and recognize it.
I want to see baristas take better advantage of the education the SCAA offers.
I want to see Camp Pull-A-Shot a complete success again.
I want to see regions better represented under our current Regional Chapter Reps through a new council.
And what can you do to help make it happen? You can volunteer your time mentoring others, helping to create community coffee events, and working hard to make specialty coffee more viable and appreciated where you live.
Jason: I have to say that spending time with my wife is my favorite thing, and I mean that. She's really my best friend, and hanging out with her doing anything is pleasurable. I also own a MINI Cooper S, and we love taking rides in it, especially in the mountains on the curviest of roads, as fast as we can. We are members of a local MINI club, and do drives and scavenger hunts with them frequently. I also love playing disc golf, and do it every chance I get.
Coffee Kings: You’ve distinguished yourself among your peers for your skills, work ethic, knowledge and welcoming manner. Those are all skills that make not only great employees but also excellent owners. Do you have any aspirations for owning your own shop one day?
Jason: I started off in coffee by opening two coffee shops. I remember the amount of stress and challenges that came along with that, and I'm not interested in getting back into from that perspective. One of the great things about my position now, is that I take all of my coffee experience over the past 14 years, and use it to help others opening coffee businesses. Each one is a project with great consequences, so I take pride in helping them as best I can be successful in their coffee business utilizing the things I would be putting into practice as a shop owner myself.
Coffee Kings: I’ve been a little critical and skeptical about manual brewing, something you are deeply passionate about. Tell me about your participation in the US Brewers Cup Championship and whether you think it can achieve what the Barista Championships has relative to improving the quality of the products served across the industry.
Jason: I am a huge proponent of manual brewing for several reasons. One, I love the fact it brings back a level of focus and communication between the barista and the customer. Second, I love the taste of properly manually brewed coffee. Third, It's easy to do, and allows you to brew lots of different coffees quickly. I think currently there is alot more bad manually brewed coffee than there is good, but I know that you could say the same for espresso. And all we can do as coffee professionals is train as many fellow baristas as we can as how to properly brew it, and how extraction works.
As far as the Brewers Cup, I think it's a good start. I had some issues with how it went down in Houston in terms of judges calibration, but this was their first year, and for the first year, I thought it was done well. It's definitely a great launching point for a competition that could be really cool to see. I'm all about seeing baristas pushing each other to brew better coffee. I really do think it will encourage baristas to learn to brew better coffee. I think the challenge is that baristas don't understand exactly what the judges are looking for in a cup of coffee, what a Q grader is looking for. I know it will get better, and the organizers will take a look at what went well, and what needed improvements and make positive changes.
Coffee Kings: I know you’ve conducted some research about the level of income baristas around the country are achieving. What do you hope to do with the results and what is your opinion of the barista income in the USA?
Jason: I wanted to show that baristas wages are relatively the same across the US, and baristas can improve their wages by investing in themselves. I believe that baristas don't make enough for what they do, what they put up with, and how much time they invest into themselves and their career.
Coffee Kings: One of the things I think is an obstacle to growing the BGA into an influential entity within the industry is an impression that unless you compete or intend on competing, there is nothing for you within the BGA. How do you address the concerns of working baristas and make them feel as valued as competitors.
Jason: I have never competed in a barista competition. I have no desire to compete in one. At one point, I was the only Executive Council member who was not either a US Barista Champion, or at least a Regional Champion. The BGA has always been for me a guild for all baristas, not simply ones who compete. I've never noticed a focus on competitors, it's just that most of our logos and branding shows up around competitions. I do not agree that if you're not a competitor there's no value for you. Because there has been for me in all my time as a BGA member, and being able to be more active in shaping the BGA, and now becoming the chair, proves that point. At Camp Pull-A-Shot, there were tons of great baristas who are not competitors, taking advantage of just one aspect of what the BGA has to offer. The BGA is for ALL baristas, and shows no favoritism.
Coffee Kings: I’ve noticed over the past 4-5 years especially that there appears to be a segmentation of coffee companies with several being promoted as either the best, freshest, most exclusive, highest quality, hippest etc, etc. I seems to me that most of the praise is focused on a few, where there are literally dozens achieving the same quality without recognition. Is this phenomena concerning to you? Tell me about one or two excellent companies who deserve more attention.
Jason: I will agree that historically, the roasters who speak the loudest get heard the most. I will also agree that there are tons of great roasters all around the country that don't get tons of attention. I blogged about this just today. I think roasters that should get more attention are PT's Coffee, Klatch Coffee, and Kaldi's Coffee.
Coffee Kings: What is the participation rate of BGA members in the election process? Do you think the rate of participation harms the ability of the BGA executive to move the association in new directions?
Jason: We had great participation in the past election, some of the best we've had. We also posted up a survey that allowed us to hear from the membership on a larger level, and we have taken all of the feedback to heart, and are acting on it. I feel like we totally understand what our members are looking for in the BGA, and are working as hard as we can as volunteers with full-time jobs and multiple other involvements in the industry, to make it happen.
Coffee Kings: As an international member I can vote for executive positions within the BGA but not regional representatives. Are there any plans to create a seat for international representatives on the executive board in the future?
Jason: We have spoken about an international BGA rep, and have been working on creating that position, who it would be, and what that would look like.
Coffee Kings: You’ve been supportive of the Coffee Common initiative held at the TED Conference in Palm Springs, something I’m less enthusiastic of. I see the Coffee Common as something dismissive and harmful to the SCAA, tell me where I’m wrong.
Jason: "The rising tide floats all boats."
Coffee Kings: If you could pick one thing that you hope to accomplish this year on behalf of the BGA membership, what would it be and how can we all help to make it happen?
Jason: The things I'm most passionate about are:
making sure that baristas all over feel valued and appreciated, no matter who they work for, or where they live.
I want to see the Certification thrive, and baristas and shop owners see the value in it.
I want to see us value and appreciate all the work that has been done before us on the BGA, and recognize it.
I want to see baristas take better advantage of the education the SCAA offers.
I want to see Camp Pull-A-Shot a complete success again.
I want to see regions better represented under our current Regional Chapter Reps through a new council.
And what can you do to help make it happen? You can volunteer your time mentoring others, helping to create community coffee events, and working hard to make specialty coffee more viable and appreciated where you live.
Sunday, May 15, 2011
Dropping Off The Table
I can't think of another Macro Economic topic which affects our industry, from grower to consumer, more than the Commodity Price for coffee. I blogged earlier this year in support of the possibility that prices still had room to move up, and listed many reasons I believed contributed to increased prices. I feel that we touched the top of the market last week and that we will see a weakening of prices throughout the year. As part of an ongoing series of personal opinions and observations I want to express my belief that coffee prices are due to fall significantly this year for the following reasons.
1. The market price for coffee is to be viewed within the context of commodities in general. Commodities are an investment class which has been on a Bull Run for several years due in large part to the low returns to be had in bonds and notes and the devastation of the equity markets beginning in 2008. Commodities have attracted huge sums of speculative investors employing permissive leverage ratios to force the market up. Recently exchanges have increased the capital requirements for leveraged accounts, which will reduce the participation, thereby reducing the liquidity in the markets. Reduced liquidity means lower prices. The other thing about leverage is that while it is very lucrative in a contango market, when things go backwards, margin calls come in which necessitates selling. The more the price drops, the more margin calls, the more the price drops, the more margin calls...
2. Reports have been surfacing of brokers and exporters hoarding coffee at origin in an effort to keep prices high. While it is impossible to determine how much coffee is being hoarded, what I can predict is that when the hoarders start selling, they will all sell. More sellers than buyers moves the price down at an accelerated rate which feeds developing panic should things turn bad.
3. I perceive a disconnect between a natural price for Commodity Coffee, and the current price. Those of us who've been around the block a few times remember the spikes and valleys, but through the process gain an understanding of what price is a fair representation of the value of commodity coffee. That fair value is not $0.45 or $3.05, but somewhere in between. My guess, and it is a guess, is that an equilibrium price for coffee is approximately $2.00 per pound. In my view, this is not so high as to encourage new and inefficient participation, but not so low as to discourage participation. We can all find a price that feels right to them, but to me $3.05 is not it.
4. As I've blogged about in the past, the relative weakness of the US Dollar is responsible for at least 30% of the current "C" price. If the USD shows any real strength, (not a spike resulting from a flee from the euro) the commodities will drop very quickly. The USD has been weak since the government began printing money in an effort to provide needed liquidity once the credit markets seized. We already know the program referred to as Quantitative Easing will end in June of this year, reducing the money supply. When a government reduces the amount of currency circulating, the value of that currency rises, which is a bad thing for commodities. Also, North America currently has very low interest rates set by each government as a "Key Interest Rate". Those rates are one tool the Federal Reserve or in the case of Canada, the Bank of Canada, control economic activity. If the rates are low the Reserve thinks it needs to encourage economic activity. Moving the rates higher is a sign that activity is picking up and the Reserve needs to control activity by making it more expensive to finance things. The rates also are reflected in the Bonds issued by each government. When interest rates increase, the attractiveness of American Bonds increases making the USD rise. This is of course a very different situation from some Euro Countries that need to raise bond rates to encourage someone to buy them accounting for the risk of default. If the US Dollar index moves into more historical range as a result of any of these factors, the price for coffee will drop to close to the $2 level.
5. I may be wrong, but I think the market participation of the BRIC countries is overstated. Brazil, Russia, India and China are not doubt huge markets, but while they will need rare earths, raw materials and fuel to grow, coffee will need to destroy well entrenched cultural preferences to gain any traction. I understand that Brazil has made great efforts to increase coffee consumption which is intended to support a domestic industry, but there will be no similar efforts on the part Russia, India and China to alter beverage habits of their citizens. When markets like coffee increase unexpectedly it is easy to point the finger at the huge populations across the Pacific Ocean and expect the general public to accept it as plausible. I just don't believe it.
6. Coffee right now is not a good buy, it's a good trade. For the vast majority of participants buying a contract is a trade they expect to sell before taking delivery. In some particularly volatile sessions, traders hold a contract for less than an hour, and in some cases less than 5 minutes. These are the individuals setting the price, and when they feel the better trade is to short the market, that's the way it will move. Reduced liquidity resulting from margin calls will feed the fire.
For these reasons I think we can expect the "C" to find a level somewhere near $2 by the end of the year except in the case of unforeseen weather events. Time will tell if I'm right, but my feeling is when it starts to move down, it will drop off the table.
1. The market price for coffee is to be viewed within the context of commodities in general. Commodities are an investment class which has been on a Bull Run for several years due in large part to the low returns to be had in bonds and notes and the devastation of the equity markets beginning in 2008. Commodities have attracted huge sums of speculative investors employing permissive leverage ratios to force the market up. Recently exchanges have increased the capital requirements for leveraged accounts, which will reduce the participation, thereby reducing the liquidity in the markets. Reduced liquidity means lower prices. The other thing about leverage is that while it is very lucrative in a contango market, when things go backwards, margin calls come in which necessitates selling. The more the price drops, the more margin calls, the more the price drops, the more margin calls...
2. Reports have been surfacing of brokers and exporters hoarding coffee at origin in an effort to keep prices high. While it is impossible to determine how much coffee is being hoarded, what I can predict is that when the hoarders start selling, they will all sell. More sellers than buyers moves the price down at an accelerated rate which feeds developing panic should things turn bad.
3. I perceive a disconnect between a natural price for Commodity Coffee, and the current price. Those of us who've been around the block a few times remember the spikes and valleys, but through the process gain an understanding of what price is a fair representation of the value of commodity coffee. That fair value is not $0.45 or $3.05, but somewhere in between. My guess, and it is a guess, is that an equilibrium price for coffee is approximately $2.00 per pound. In my view, this is not so high as to encourage new and inefficient participation, but not so low as to discourage participation. We can all find a price that feels right to them, but to me $3.05 is not it.
4. As I've blogged about in the past, the relative weakness of the US Dollar is responsible for at least 30% of the current "C" price. If the USD shows any real strength, (not a spike resulting from a flee from the euro) the commodities will drop very quickly. The USD has been weak since the government began printing money in an effort to provide needed liquidity once the credit markets seized. We already know the program referred to as Quantitative Easing will end in June of this year, reducing the money supply. When a government reduces the amount of currency circulating, the value of that currency rises, which is a bad thing for commodities. Also, North America currently has very low interest rates set by each government as a "Key Interest Rate". Those rates are one tool the Federal Reserve or in the case of Canada, the Bank of Canada, control economic activity. If the rates are low the Reserve thinks it needs to encourage economic activity. Moving the rates higher is a sign that activity is picking up and the Reserve needs to control activity by making it more expensive to finance things. The rates also are reflected in the Bonds issued by each government. When interest rates increase, the attractiveness of American Bonds increases making the USD rise. This is of course a very different situation from some Euro Countries that need to raise bond rates to encourage someone to buy them accounting for the risk of default. If the US Dollar index moves into more historical range as a result of any of these factors, the price for coffee will drop to close to the $2 level.
5. I may be wrong, but I think the market participation of the BRIC countries is overstated. Brazil, Russia, India and China are not doubt huge markets, but while they will need rare earths, raw materials and fuel to grow, coffee will need to destroy well entrenched cultural preferences to gain any traction. I understand that Brazil has made great efforts to increase coffee consumption which is intended to support a domestic industry, but there will be no similar efforts on the part Russia, India and China to alter beverage habits of their citizens. When markets like coffee increase unexpectedly it is easy to point the finger at the huge populations across the Pacific Ocean and expect the general public to accept it as plausible. I just don't believe it.
6. Coffee right now is not a good buy, it's a good trade. For the vast majority of participants buying a contract is a trade they expect to sell before taking delivery. In some particularly volatile sessions, traders hold a contract for less than an hour, and in some cases less than 5 minutes. These are the individuals setting the price, and when they feel the better trade is to short the market, that's the way it will move. Reduced liquidity resulting from margin calls will feed the fire.
For these reasons I think we can expect the "C" to find a level somewhere near $2 by the end of the year except in the case of unforeseen weather events. Time will tell if I'm right, but my feeling is when it starts to move down, it will drop off the table.
Friday, April 29, 2011
Eleven Questions for Paul Stack of Marco
I have posted several times on the subjects of manual brewing and equipment purchasing as they apply to financial statements and profitability modelling. As a special feature heading into the Specialty Coffee Association of America annual trade show and conference in Houston Texas, I have posed some questions to Paul Stack of Marco located in Dublin Ireland. Marco is on the leading edge of technical innovations in hot water delivery systems suited to shops and roasters alike.
Coffeekings: Marco and Uber project may be something unknown to many in the North American coffee business. What core business was the company founded on?
Paul: Marco is 30 years old this year, which is surprising to some. The core business is the design and manufacture of hot water delivery systems for the food and beverage industry. This is embodied in the design and production of both hot water systems and automatic filter (drip) coffee machines. However we only sell hot water systems in North America for now.
Coffeekings: Innovation, research and development, and entrepreneurship are extremely challenging at the best of times. Do you perceive Marco in an R&D/building phase or approaching a marketing/management phase of the business cycle?
Paul: Both, to be honest. Innovation and R&D is incessant in Marco. It is our future. Parts of our business are very much on the marketing/management side but probably more so in the more traditional mature Marco markets.
Coffeekings: There are plenty of examples within the coffee industry that support the notion that great talent is attracted to great companies. Marco is also blessed with some knowledgeable and skilled staff. Tell me about some key staff and what they contribute to the company.
Paul: People are attracted to companies which will offer them an experience aligned with their own personal and professional ambitions. To be part of something they believe in. We have a lot of great people and I am loathe to single any out. An exception- Drewry Pearson, our Managing Director is something of a visionary and singular in the drive for innovative product offerings with an underlining belief in continuous education. We have very knowledgable and caring people looking after customer service including after sales care. To use sporting parlance, they play in a position to which they are suited. They give the business a solid spine. Our R&D team is a great mix of abilities from mech eng to software design to industrial design to innovation and research into market need. I could go on but it's a bit trumpet-blowing. In short, we have a good team.
Coffeekings: Ireland is undergoing a very challenging time for businesses and finance due largely to banking and real estate collapses. Describe for me the sentiment among Irish businesses regarding access to needed credit, availability of willing buyers for your products, and prospects for the future.
Paul: Ireland has been gorging in the greedy trough for too long and it's payback time. As always with these things, those who gorged and those who pay are misaligned. Established businesses like our own are lucky to have cash strength and a strong banking history, allowing us to continue to invest in our chosen strategic direction even in the face of market uncertainty and revenue dips in our home market in '09/'10. Newer companies with great opportunities are being hamstrung by the lack of credit available. Some banks in Ireland are money collection bureaux rather than financing institutions. Thus, the gears of Irish recovery are sticking as the lubricant that is fluid financial structures is lacking.The core economy in Ireland is strong. A stupid decision to make bank debt sovereign debt is the millstone we carry as a nation. For that, business sentiment is a mixture of simmering anger tinged with embarrassment as brand Ireland has taken a blow.
Coffeekings: Ireland is a touchstone for millions of Diaspora generations removed from the Island, and in many ways has always influenced the world well beyond their population. On my first visit I was struck by how advanced Bewleys on Grafton Street was compared to North American counterparts in terms of quality and traceability. To what do you credit the incredible depth of coffee talent in such a small population?
Paul: I'm not sure the coffee talent in Ireland is that deep, loud maybe...... Regarding coffee and Ireland, Patrick Bewley was at the forefront of a lot of what has become the Irish speciality coffee scene. He invested heavily in the SCAE, both personally and professionally. He was a founder member and is a past president of SCAE. In his own company he invested heavily in the training and education of his staff. Most of the coffee companies in Ireland with speciality leanings have either a founder or some of their team who is ex-Bewleys, including Marco. In the last five or so years Drewry Pearson has taken up the baton, more so from a patron viewpoint nationally while being at the forefront internationally, being a board member of the SCAE and WBC (now WCE). Nationally, he was the prodding stick behind 'internationalising' the Irish Coffee Championships, the SCAE Gold Cup and a strong education content in the Irish industry.
Coffeekings: I had been following the progress of Uber boiler online for some time before marveling in Anaheim at its beauty, advanced technology and logical solution to problems faced in manual brew methods. Please describe the problem it was designed to solve and some technological barriers to achieving success.
Paul: As most know, the Uber Boiler was the result of a one off project with a nascent London coffee company called Square Mile Coffee Roasters in 2008/2009, at the time comprising the impressive trio of James Hoffmann, Anette Moldvaer and Stephen Morrissey. Our challenge was to produce one under counter water delivery system with counter top font to deliver water to within 1 degree Celcius of a chosen temperature, which could pour directly onto a weighing platform. This would allow James et al cup coffees with accuracy allowing them highlight nuances. While we already had undercounter systems, their accuracy was approx +/-2.5C and there was no weighing platform. Tightening the accuracy was the key challenge. The rest was packaging and having a will to do it.
Coffeekings: Where are the uber boiler manufactured and how much time is required to take one from shop drawing to tabletop? Have you considered licensing the technology to larger manufacturers and focusing on marketing and distribution?
Paul: Uber Boilers are manufactured in our production facility in Dublin, about 7 miles from the city centre. We build four Ubers per run. Build time from punching steel to boxed Uber is 4 days. As the Uber Boiler is a constant work in progress I haven't considered licensing the technology. Is someone interested ?
Coffeekings: It seems to me that the past 5 years or so have become a period where companies are applying increasingly advanced technologies to address problems posed by increasingly simpler brewing techniques. One of the problems I see with manual brewing is the increased labour and wait time. How has the uberboiler addressed these problems?
Paul: It has and it hasn't. That's a bit Irish, eh? It has by giving the Barista a workstation from which (s)he need not move and can engage with a customer, thus maximising efficiencies and customer service. More importantly, it hasn't as it is not designed to decrease wait time. The ECOBOILER & ECOSMART series do that.
Coffeekings: The most visible elements of the high-end coffee market communicate at length about the subtle nuances and characteristics of their coffees cupping profiles. This sort of customer interaction can pay big dividends but only if the customer can distinguish the traits too. What about the uberboiler increases the chances of successfully brewing coffee to reveal the desired profiles.
Paul: Precision. At its heart is the UberBoiler's capability to allow the Barista change every brew variable, from coffee to water ratio (+/-0.5g) to contact time (+/-1s) to temperature (+/-0.1C) to turbulence (via flow rate and flow direction).
Coffeekings: Marketing and distribution are for me big black holes for profits and cash flow. What is the marketing strategy for Marco and how are you addressing distribution in North America?
Paul: Never a truer word spoken. We never targeted North America. The uber project dragged us there. It would have been too big a step for us to set up Marco USA when that opportunity presented. La Marzocco USA handle our brand and our product in North America, exclusively in the US. The alignment of both companies' brand positioning, strategic intent and vision coupled with the simple fact that we get on well made it an easy decision.
Coffeekings: One thing I like to repeat to staff is we don’t get to choose our customers, they choose you. Are there any customers using Marco’s products and services that surprise you by not fitting the target customer profile. Is anyone using the uber boiler for products other than coffee and do you market to any other industries?
Paul: It's a great question to which I am unsure how to answer. Our products are used widely in catering institutions where the need is often basic regarding brewing but crucial regarding reliability, ease of use and service. Cost of ownership and our products' energy-saving credentials are fast becoming as big a decision factor as the customary features of well-designed, well-made kit which do the job. Regarding Uber Boiler, it's main and happiest home is the cupping room or the Barista-driven brew bar. It is also used in gourmet tea shops.
Thursday, April 14, 2011
Ratios
I look at my P&L, Cash Flow and Balance Sheet almost daily out of habit, probably like a child checks to make sure their favourite toy is still on the shelf where they left it. This morning I noticed something out of whack after our bookkeeper made updating entries after some Green Bean purchases. Our ratios are off.
Normally my ratios are pretty close to the following: Cogs 40%, Labour 25%, G&A 20%, EBIDTA 15% with some minor seasonal changes resulting from the fact that I treat labour as a fixed cost since if we aren't busy, I don't send anyone home.
This morning my ratios showed: Cogs 51%, Labour 14%, G&A 13%, EBIDTA 22%.
So what's going on.
As most of you are experiencing first hand, green coffee prices have increased significantly and last years stock has pretty much been exhausted leading me to rely more on spot coffees which are carrying higher prices than last year's. In advance of this years bookings with the understanding that prices won't plummet any time soon I raised all prices across the board to accommodate the new reality. These two moves necessarily reduce the overall impact of labour and G&A while sometimes helping the bottom line. As I stated before, labour for me is considered fixed, therefore any price increase which doesn't reduce volume must make labour more productive and profit positive. Since we are increasing revenue without increasing traditional fixed costs such as rent, utilities, phone and legals other than what is predictable, those costs as a portion of sales are reduced.
While the exact impact of increased COGS and Prices cannot be known ahead of time, using a spreadsheet to quickly inject new costs and produce corresponding pricing is a great way to monitor profitability in a foolproof way. The spreadsheet I use employs fixed per pound costs which are adjusted semi annually to reflect increase/decreased G&A and labour. The inputs for COGS are changed almost weekly now, and once I push beyond a price by 5%, I make a change in our wholesale pricing. If you get nothing else from this post take this part to heart, look at your Financials every day and learn your own ratios. It is a great way to see trouble on the horizon well before anyone else notices.
Normally my ratios are pretty close to the following: Cogs 40%, Labour 25%, G&A 20%, EBIDTA 15% with some minor seasonal changes resulting from the fact that I treat labour as a fixed cost since if we aren't busy, I don't send anyone home.
This morning my ratios showed: Cogs 51%, Labour 14%, G&A 13%, EBIDTA 22%.
So what's going on.
As most of you are experiencing first hand, green coffee prices have increased significantly and last years stock has pretty much been exhausted leading me to rely more on spot coffees which are carrying higher prices than last year's. In advance of this years bookings with the understanding that prices won't plummet any time soon I raised all prices across the board to accommodate the new reality. These two moves necessarily reduce the overall impact of labour and G&A while sometimes helping the bottom line. As I stated before, labour for me is considered fixed, therefore any price increase which doesn't reduce volume must make labour more productive and profit positive. Since we are increasing revenue without increasing traditional fixed costs such as rent, utilities, phone and legals other than what is predictable, those costs as a portion of sales are reduced.
While the exact impact of increased COGS and Prices cannot be known ahead of time, using a spreadsheet to quickly inject new costs and produce corresponding pricing is a great way to monitor profitability in a foolproof way. The spreadsheet I use employs fixed per pound costs which are adjusted semi annually to reflect increase/decreased G&A and labour. The inputs for COGS are changed almost weekly now, and once I push beyond a price by 5%, I make a change in our wholesale pricing. If you get nothing else from this post take this part to heart, look at your Financials every day and learn your own ratios. It is a great way to see trouble on the horizon well before anyone else notices.
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