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Position Management for Roasters


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This presentation explores two oft-confused elements of coffee roaster position management: exposure to green coffee market prices, and green coffee inventory management.

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Position Management for Roasters

  1. 1. Position Management for Coffee Roasters David Joelson NCA Convention March, 2014
  2. 2. Position Management – Who Cares? 1. The market is on a ferocious bull run “I sure hope we bought lots of coffee when prices were lower… what’s this going to do to my P&L this year?” 1. The market is dying, looks like it could go to zero “I hope we don’t get stuck with too much high priced coffee….will we be competitive? Will our customers who locked in prices be competitive?” 3. The plant just shut down. “WHERE ARE THOSE GUATS?”
  3. 3. Position Management 1. Risk Management -- Managing Exposure to Market Prices “I don’t want to bet the company’s fortunes on our ability to call the market correctly every year.” 1. Inventory Management “Prudent inventory management should not cause extreme price exposure” Manage risk and inventory separately. They do not overlap
  4. 4. OK Slight Overlap Differential Mgt.
  5. 5.  4 Myths  What Matters  Having a strategy  Measurement/Data  “Hidden” risks derived from market price moves  Having a futures account I. Managing Exposure to Market Prices
  6. 6. Myth 1: “We only buy specialty coffee so we have no exposure to market prices” Source: J Ganes Consulting, LLC Guatemala SHB FOB Price vs C Market 2004 -- 2008 60 80 100 120 140 160 180 CentsperLb C Mkt Guat SHB
  7. 7. Myth 2: “You’re a roaster therefore you are always short”  What is your true position before any hocus pocus? Short: profit from a down market Long: profit from an up market Neutral: Market has little impact on results  True position can differ by business segment  Hedge: Used to offset true position
  8. 8. Myth 3: “I got a ton of inventory on hand so I can turn off the screen for at least a week”  Combines independent items: inventory levels and market exposure.  Use of physical coffee to manage market risk is expensive and inflexible
  9. 9. Myth 4: “The most important thing is how much priced coverage we have”  If you maintain constant priced coverage… Must buy replacement every day So how does it matter how long you are*? *OK it matters a little: Length of coverage will determine WHEN today’s purchases will hit your P&L Impact of Market structure…in a normal market will pay extra for distant coverage approx. 1 cent/Lb per month (Arabica)
  10. 10. So What Matters  When do you add coverage  When do you draw down coverage A disciplined approach, informed by your market view but not wholly dependent on it
  11. 11. Priced Coverage Matrix New York Coffee Futures Example (coverage in weeks) Market View Market Price Bearish Neutral Bullish < 72 13 – 15 16 – 18 19 – 21 72 – 106 11 – 13 14 – 16 17 – 19 106 – 121 9 – 11 12 – 14 15 – 17 121 – 154 7 – 9 10 – 12 13 – 15 > 154 5 – 7 8 – 10 11 – 13 Assumes reversion to the mean Within a price range, target longer when bullish, shorter when bearish For a given view, extend at low prices, draw down at high prices
  12. 12. Estimated Colombian Diffs: Volatile but Within a Tighter Range Source: ICO Indicators and 2nd position NY Futures used to estimate differentials. YMMV. Monthly average futures has a range of 240 cents, estimated Colombian diffs 80 cents.
  13. 13. Differential Coverage Matrix Colombian Example (coverage in weeks) Market View Market Price Bearish Neutral Bullish < 5 15 – 22 22 – 28 26 – 40 5 – 8 13 – 18 16 – 21 17 – 30 8 – 14 10 – 15 12 – 14 15 – 28 14 – 23 9 – 12 10 – 12 13 – 20 > 23 8 – 10 9 – 11 11 – 13 Source: ICO Indicators and NY Futures used to estimate differentials. Monthly Averages used. YMMV. Policy matrix on differential coverage is normally limited on the short end due to length of physical pipeline
  14. 14. How to Calculate Coverage  What is included in price coverage? Priced purchases Green Inventory (if priced) and Work in Process (green basis)* Finished Goods (green basis)* Futures and delta-equivalent options  Differential Coverage – Inventory* plus open purchases  Recommendation: convert Tonnage to Weeks using annual average consumption *If LIFO accounting, anticipated year-end inventory is not included in coverage
  15. 15. Priced Coverage
  16. 16. Hidden Risks Associated with Markets Risk Market Condition Mitigate Risk Supplier defaults causing replacement at much higher price Rising Market • Defer pricing until shipment (hold futures) • Track M2M by supplier Supplier ships late/not at all disrupting operations Rising Market (usually) • Alternative blends • Awareness of spots • Early warning signals (e.g. no pre-ship sample) Lack of spot coffees to handle unanticipated needs Inverted market ( = scarcity & rising prices) • Alternative blends • Sales lead times • More inventory Customer orders exhibit “adverse selection” depending on the market Moving Markets • Track customer sales & enforce contracts Quality Risk Extreme markets • Pre-shipment samples Operational Risk: A Yacht called “The Unable” Moving Markets • Get educated • Segregate duties • Spot checks
  17. 17. Futures Account: Should you have one?  Advantages Concentrated orders Reduce counterparty risk – hold your own futures Improve control More techniques available – options, swaps, switches Protected by SEC/Exchange rules Role of clearinghouse – Mark to Market fully funded  Disadvantages Initial & variation margin – risk of cash outflow. However: Variation margin (for a long position) is required in falling markets … when less cash is required to finance inventory In rising markets, variation margin will generate positive cash Increasingly complex accounting Cost of broker commission (small)
  18. 18.  Tips  Tools Terms  Vendor Managed Inventory (VMI)? II. Managing Inventory
  19. 19. Inventory Management  Conflicting objectives Ensure supply Keep inventory low (cash/quality/leanness)  Challenges Uncertain demand Forecasts become less accurate at the lowest levels Long/variable supply line
  20. 20. Tip: Classify Green Types for Inventory Management Green Type General Characteristics Strategy Unique  Limited supplies  Seasonal  Few or one supplier  No substitutes  Expensive  Unique: cup or story  Strong strategic reason for being  Hi inventory target when its available  Monitor quality  Monitor sales closely  Seek substitutes or complementary products Common  Plentiful supplies  Multiple suppliers  Substitutes  Available all year  Used in many products  Tighter inv. target  Leave 15-20% room in position  Watch the spots
  21. 21. Tip: Weekly supply chain or “S&OP” meetings Focus on Data  Identify & Understand Variances Sales Production Green usage  Especially Watch Unique Items Example: Explore why we used so much more Colombian Coffee than planned last week. Is this a real change in requirements or just a shift between weeks?
  22. 22. Purchasing Terms: What is optimal for you? Terms Coffee Price Cash Required Admin Effort FOB Origin Lower Higher Higher C&F/CIF Ex-Dock Ex-Whse./Del’d Vendor Managed Inventory (VMI) Higher Lower Lower Within these choices, still need to clarify other terms such as: •Quality rejection terms •Payment terms •Buyer influence on sourcing: Relationship coffees? Preferred shippers? •Rules/costs around taking coffee late R E S P O N S I B L E F O R I M P O R T I N G
  23. 23. Benefits & Costs of VMI  Benefits to Buyer One time cash (reduced inventory) Less admin effort Suppliers have increased flexibility  Costs Supplier charge for holding coffee Premium for delivery timing uncertainty Reduced competitive bidding