The Potion of the Arabs
Soroush is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
When people think of commodities trading, they normally consider a Middle Eastern good consumed primarily by advanced nations. While this is obviously an apt description of oil, it also paints a picture of coffee, the second most frequently traded good in international commodity markets. The demand for these two products follow similar patterns—as nations industrialize and experience augmented wealth, their appetite for these goods rapidly increases.
At first glance, it may be difficult to see an obvious connection between coffee and crude oil. Although coffee originated in the Middle East (it is called “the potion of the Arabs” in Latin), it is primarily grown in Latin America and Southeast Asia. Its production is not governed by powerful cartels, and, unlike petroleum, devastating climate change may actually eliminate its growth. In other words, coffee is generally associated with organic tree-huggers, while harem-keeping sheiks control black gold. These differences are valid. However, they reflect not an endogenous truth but rather a self-preserving shift that has taken place in the coffee industry. Prudent investors recognize the untapped potential in emerging markets slowly wading into the tastes of luxury. International players recognized the threat of the growing sustainability movement that could have unnecessarily harrowed the market. Such is how a product traditionally associated with slavery and, post-Green Revolution, with deforestation and habitat destruction, has now become a symbol of how corporations can co-opt seemingly ineluctable market forces to increase profitability.
There are two reasons consumers drink coffee. The first is the actual benefits of the product—namely its basic flavor and quantity of caffeine. The second is coffee’s growing image as a luxury product. Since the introduction of coffee to the European world from the Middle East and North Africa in the 16th century, a rising middle class (represented first by Venetian merchants) has reveled in its ability to consume the imported delectable. This trend was enhanced by the discovery of java nirvana (Southwest Asia) by Dutch traders. Now China and India – two emerging nations much closer to bean production – contain burgeoning professional classes eager to spend their newfound wealth. Coffee consumption is increasing at a clip of 15-30% per year in China, which is especially meaningful considering the 1.3 billion people in China currently only drink five cups of coffee per year. For comparison’s sake, the caffeine addicts in Finland each take in a good 1,500 annually.
The growth of the coffee culture in these countries is partly a product of increasing Westernization. Subway and McDonalds are supplemented in the Middle Kingdom by Starbucks (NASDAQ: SBUX), who just announced a tripling of its presence there over the next three years. Unlike other globalizing trends, however, China actually produces the bean. This is a key factor that distinguishes coffee from petroleum. While discovery of oil in new locations (i.e. the current exploration of the Arctic) increases the commodity’s supply, the addition of new coffee bases shifts the valuation of coffee itself. Coffee companies realize they can raise their credibility with environmentalists by utilizing supply stock in exotic places and subsequently marketing it with a Fair Trade symbol. The future of coffee is a green one, which provides coffee drinkers with the elevated self-worth of someone who gets to indulge in Ethiopian Yirgacheffe.
The coffee industry suffered a scare in 2008-2009, as retailers such as Starbucks severely over-expanded, eventually leading to the closing of several unnecessary stores. However, while coffee chains suffered losses, coffee consumption did not decrease. The increase of demand in developing countries was supplemented by the revolution in the personal brewing market—Keurig’s single-cup coffee maker allows individuals to save time. K-cups also reduce waste, raising companies’ profit margins on the 50 cent prepackaged amounts. While Starbucks, Dunkin Donuts (NASDAQ: DNKN), and Caribou Coffee (NASDAQ: CBOU) may have suffered in the late-aughts, they have realized the value of personalized brewing.
For individuals looking to gain a broad exposure to this industry, the iPath DJ AIG Coffee TR Sub-Idx (NYSEMKT: JO) and the iPath Pure Beta Coffee ETN (NYSEMKT: CAFE) offer a diversified approach, though both have been down nearly 50 percent over the past year, as supply boons have sent coffee prices to a level not seen since mid-2010. The best pure coffee play looks to be Starbucks, which is trading below historical averages from an earnings perspective. Specifically, the stock's earnings are currently valued at a 115 percent premium to the S&P's average. This is cheaper than its 10-year historical premium of 123 percent. This undervaluation seems unwarranted, as analysts expect earnings to grow by 10 percent a year over the next half decade; growth which is at least partially driven by the company's recent acquisition of Evolution Fresh, and the expected sales of its new single-serve coffee brewer Verismo. Additionally, Starbucks has been reportedly in plans with Coinstar to build an array of Seattle's Best kiosks throughout the U.S. To learn more about how the future may be filled with these types of kiosks, continue reading here.
All in all, the coffee industry is rapidly developing, undeterred by the sudden surge of caffeine-heavy energy drinks. Innovation is continually made, and there is no sign short of devastating climate change threatening to damage its worth. For more information on this topic and other trading ideas, visit WealthLift INSIDER today.
This article is written by John Kocsis and edited by Jake Mann. They don't own shares in any of the companies mentioned above. The Motley Fool owns shares of Starbucks. Motley Fool newsletter services recommend Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.