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Sweet Fortunes in Cocoa

The Rise of the Candy Baron

Written by Briton Ryle
Posted May 30, 2014

While consumers are well aware that chocolate candies contain a long list of artificial ingredients and flavors, there is something else that is artificial about chocolate which most are not aware of: its price.

Despite a growing demand for chocolate around the world year after year, cocoa bean prices had actually fallen between 2011 and 2013 to their lowest levels in five years. Some accuse candy manufacturers of colluding with one another to fix the price they pay African farmers for their cocoa beans in order to increase their profit margins.

But they may have shot themselves in the foot, since keeping the cocoa price artificially low is driving farmers to other crops, creating a shortage of cocoa while global demand keeps rising.

It looks like candy manufacturers have really done it now. Cocoa prices are once again on the rise, and there seems to be no way to stop it now.

Confectioners Leave a Bitter Taste in Farmers’ Mouths

To farmers in the world’s largest cocoa-producing regions of Ivory Coast and Ghana on Africa’s west coast, there is nothing sweet about cocoa farming anymore.

“Cocoa farmers are becoming more aware of the bad deal they’re getting on the cocoa value chain,” revealed Edward George, head of soft commodities research at Ecobank Group.

As noted in the graph below, after skyrocketing 271% from $1,400 per ton in 2006 to $3,800 by early 2011, cocoa bean futures went into a steep nosedive, losing 47% in just 10 months, closing 2011 in the $2,000 per ton area.

Cocoa Futures

Source: TradingCharts.com

It is believed that candy manufacturers colluded to fix prices both while cocoa futures were on the rise and again when they were falling.

The first fixing came when cocoa prices were on the rise, when North America’s largest candy makers were alleged to have colluded to raise their products’ retail prices from 2002 to 2008 to offset their production costs. In 2013, Canada’s Competition Bureau laid criminal charges on the Canadian branches of Mars and Nestlé, which the companies are fighting, while Hershey Canada pled guilty and accepted a $4 million fine.

The American companies of the same three candy makers plus the U.K.’s Cadbury were defendants in another similar suit launched in the state of Pennsylvania. While Cadbury settled in 2012 with a $1.3 million fine, the other three held out long enough to see the charges thrown out of court earlier this year on the grounds of insufficient evidence.

When they could no longer get away with raising retail prices, a second wave of price fixing allegations accuse the candy manufacturers of forcing down cocoa bean futures by colluding to pay farmers less. Where Ivory Coast farmers were paid 990 CFA francs per kilogram in 2009-10, four years later they are currently receiving only 750.

Fed up with candy manufacturers’ sour deals, cocoa farmers took out their ploughs and turned their fields over, opting for more lucrative and more easily cultivated rubber tree groves.

“It takes something quite dramatic to get a farmer who has been cultivating cocoa his entire life to tear up his cocoa plantation and switch to rubber,” marveled George.

Not only are there fewer farms cultivating cocoa beans, but the ones that remain are impeded by outdated farming practices, a lack of pesticides and modern machinery, and increasingly drier weather year after year as the Sahara desert system expands. As it is, the average cocoa farm in Ivory Coast and Ghana yields a mere 0.4 tons of beans per hectare, where a properly managed farm could be yielding as much as 1.5 tons.

As a result, cocoa futures prices have been on the rise since early 2013, climbing 50% from $2,000 to $3,000 a ton. But it isn’t just falling production that is driving prices higher; increasing global demand is another ingredient being stirred into the formula.

The World’s Growing Love of Sweets

As global incomes keep rising, so do people’s consumption of candy treats. Euromonitor International estimates that global chocolate confectionery sales will reach 7.3 million tonnes in 2014 — with the sharpest rise in dark chocolate, pushing cocoa prices even higher as it requires more beans to make.

Note these expected increases in demand from around the world:

  • India’s consumption of chocolate over the next five years is expected to grow at an annual rate of 23%, according to a 2013 report by TechSci Research.

  • The Middle East’s and North Africa’s deep love of chocolate is expected to grow by 61% by 2016, according to a KPMG report.

  • Saudi Arabia’s chocolate market is expected to grow 43.5% by 2016, Euromonitor International informed.

  • China’s consumption of cocoa has already increased almost 40% from 2008 to 2012, Euromonitor International reported.

  • Hershey and other American confectioners have latched on to the dark chocolate craze, launching dark chocolate versions of their famous brands.

  • In October of 2013, Hershey announced plans to build a $250 million production facility in Malaysia to tap the growing candy market in Southeast Asia. “China in particular is growing faster than any other market,” Terence O'Day, senior vice president and chief supply chain officer, proclaimed. Once the new plant is completed in 2015, Hershey will have greater access to more than 25 markets across Asia.

  • Euromonitor International expects global confectionary demand to grow 6% annually for the foreseeable future.

  • Global cocoa production will fall short of demand this year by more than 100,000 tons, informs a Bloomberg survey of five industry analysts. “The deficit is expected to grow ninefold to 1 million metric tons by 2020, which would equal about one-quarter of global output if growers maintain the current rate of production,” the survey informs.

A Sweet Treat for your Investment Account

In light of the ever-increasing demand as developing nations expand their wealth and their taste for sweets, along with an ever decreasing cocoa supply, investors may wish to treat themselves to some sweetly performing confectionary stocks.

  • Hershey (NYSE: HSY) is a $21.59 billion large cap with exceptional returns on assets and equity of 16.68% and 59.75% respectively, with year-over-year quarterly revenue growth of 2.4% and quarterly earnings growth of 4.4%, and an EBITDA of 7.27% of its market cap.

  • Mondelez International, Inc. (NASDAQ: MDLZ), owner of Cadbury chocolate brands, is a $63.4 billion large cap with satisfactory returns on assets and equity of 3.86% and 6.08%, fairly poor yoy quarterly revenue growth of -1.2%, and atrocious quarterly earnings growth of -69.6%. But its EBITDA of 8.8% of its market cap still makes it a solid equity builder.

  • Nestlé (OTC: NSRGY), with its primary listing on the Swiss Stock Exchange, is a $249 billion mega cap with solid returns on assets and equity of 7.28% and 16.47%, stagnant yoy quarterly revenue growth of 0.3%, and poor quarterly earnings growth of -7.5%. But its EBITDA of 7.7% of its market cap keeps it in line with its peers as a decent stock appreciator.

A comparison graph below shows how each has performed versus the S&P broader market over the past five years, with Hershey leading the way up some 175% and the others trailing in the still-respectable 115% area.
While Hershey’s stock has taken a bit of a hit from rising cocoa prices, its Malaysian plant due to open in 2015 should boost its sales and profits significantly.

Candy Stocks versus S%26P

Source: BigCharts.com

Joseph Cafariello

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