Coffee Memo | Rob Talks Working Capital Ep. 4

Episode Summary
In this episode of Coffee Memo, Rob delves into the current challenges facing the coffee industry, including critical issues such as working capital constraints, evolving market dynamics, and the influence of tariffs and hedging costs. He explores the tight supply and credit situation that is impacting coffee market trends, alongside the surging current coffee prices. The discussion provides a thorough coffee market analysis, emphasizing the factors contributing to the ongoing crisis. Rob underscores the necessity for effective communication and strategic planning among roasters to successfully navigate these challenging times, while also offering insights into future developments in the coffee sector.

Episode Notes

• Tight supply and credit issues are significant coffee industry challenges.
• Robust working capital is essential for managing coffee market fluctuations.
• Current coffee prices have seen a notable increase over recent years.
• Tariffs and hedging costs contribute to financial strain on coffee importers.
• Supply chain disruptions are intensifying the crisis within the coffee market.
• Roasters must safeguard their credit lines during these challenging conditions.
• Maintaining open communication with suppliers and banks is crucial for credit stability.
• The uncertainty in the coffee market is likely to continue in the near term.
• Strategic planning is critical for roasters to adapt to shifting market trends.
• Grasping the macroeconomic factors influencing current coffee prices is imperative.

MIKE FERGUSON: Welcome to Coffee Memo with Rob Stephen, a podcast where we talk about coffee industry news and current affairs. This is episode four, and Rob is in the studio to share his thoughts on working capital. From tight supply to tight credit, the news is not great, but Rob has some insight that may help you navigate today's tough environment for coffee.

So, Rob, ages ago when I decided to go from the coffee association business into the actual coffee business, I asked a lot of people for advice about evaluating potential employers, and I heard three things over and over. Ask about their accounts payable, ask about their accounts receivable, and ask about their working capital, which can be different in coffee because of the way our business ebbs and flows and the nature of the supply chain. So, what are you seeing in our current environment when it comes to working capital?

ROB STEPHEN: Yeah, well those are good questions to ask. People who can't pay their bills have a set of problems and then people who aren't collecting money have set of problems. Because of the ebbs and flows in capital, if you don't have enough of a sort of a nest egg to weather the up and down times, then you're in trouble. And I think that's a good segue into sort of what's going on in the coffee industry today. What we're looking at right now is a shortage of capital in places that you wouldn't normally expect it.

And so, I'll talk more about that. There's been this assumption, which is an assumption I also used to share, that especially with the larger players, big multinational import-export businesses, big banks, big roasting companies, that there's sort of a, not unlimited or infinite, but very large, almost no-end-in-sight amount of capital to fund whatever you want. You want to grow into a new market, you want to do a new piece of business with a new customer, there's money for that, right? And for the vast majority of the time that most of us have been in the coffee industry, that has been true. And right now, it is really something that is not something we can take for granted anymore.

So, what has happened and what is causing it? There is a giant pool of money available for investment in the world, but it's not infinite. We saw what happened when the giant pool of money went looking for investment and invested in the wrong thing in the housing crisis. We're talking about hedge funds and retirement funds and individual investors and corporate investors and banks and private equity. Everyone's looking, they have money, they want to make money with the money. And so, stock market is a great place to do that. You instill companies and you get a return based on what you want to see from that company and what you expect out of that company.

And you can do the same thing in index markets. You can invest in commodities. A lot of people like to invest in commodities because they're often seen as very safe during turbulent times because people still need to eat and use power and build houses and things like that.

So right now we're in this place where there is a pressure to make money with money and they're putting it in places that will make the most money. And what's happened in coffee… coffee prices have more than doubled in the last say two, two and a half years. And so that follows that if you want to have the same amount of coffee, you need twice the money. Are you making twice the profit? No, unfortunately not. Right. Nobody really is. So as a result of that, there's less money available to invest in a product like coffee. Cocoa's having the same problem. They actually had a larger price increase than coffee's even had.

So ,there's sort of less money available from the investment community for coffee. So, that's the 50,000 foot view. If you're a bank and you normally fund commodity companies, you're looking at coffee and going, “meh, do I really wanna keep doing this or do I wanna double down? They need twice as much money. Do I wanna give them twice as much money?” Right, because the answer is, the next question is, will I make twice as much money? And the answer is no, right? So that's the sort of macro environment we find ourselves in.

And then as a, let's take it from our point of view, we're importers, right? So what does an importer do? Whether you're large or you're small, you do the same thing. You buy coffee from a producer or farmer or an exporter. You finance it while it's in transit. You usually put it into a warehouse when it gets here. You pay all those costs and then you hold it there until somebody buys it from you and then takes delivery. And when they take delivery, you give them an invoice. So that's the cycle of your money. The cycle starts when you pay for the coffee at origin, usually when it goes on a boat and you continue to have your money invested in that product until it is invoiced to the customer at the end of the line.

MIKE: And you're not gonna tell me there's problems on that pathway…

ROB: There may be, there may be some problems. So, the biggest problem, however, is just the sort of what we call cycle time, right? So, we're looking at from the day I pay for it to the day I get paid for it, how many times can I do that in a year, right? So, if your cycle is, you know, I buy it on January 1st and I sell it on December 31st, that's one turn in one year, right? But, if you sold it in the summer and then did it again, that's two. You were able to sell it every season. You'd have four turns, you know, those kinds of things.

Coffee importing is traditionally not a high-turn business. People want to buy coffee and they want to hold it and then take it, take it piece by piece. Right? So, you know, I want to get a hundred bags, I want to take 10 bags a month for 10 months, that, that sort of thing. Right. And so your working capital investment is gradually drawn down, but there's always some money tied up into it until the last bag is, is delivered.

So, what's been happening in coffee, there's a number of things that are happening all at the same time. In the episodes that we've done, we've talked about tariffs, we've talked about the inverted market, we've talked about just all the different pressures and volatility that's happening in the market at this time. So, those are all converging to create what I think is approaching crisis levels in working capital for coffee. So, there's tariffs whic are adding, importers pay the tariffs. Yeah, regardless of what may have been said in other occasions that the US importers are paying tariffs on coffee and on any other product that tariffs are being applied to. If the thing costs $4 and there's 10 % tariff, it's now $4.40. Yeah. Right. And so that's not money that comes from someplace else. It comes from the same pool of money that, you know, and roasters are seeing that as their prices are going up for tariff reasons as well. Right. So it flows from the source. Right. But it starts with the importer. So, the importer invests money in tariffs. Prices are at, we're not going to say historic highs because you've written several articles on the subject, but very, very high for recent history and in sort of in relation to what prices have been.

MIKE: Well, and psychologically, the numbers are… yeah.

ROB: Extremely high. Yeah. And so, you've got just the cost of the thing has gone up very high. We've added a high-cost coefficient to it, which is tariffs. And then most of this coffee is hedged. Hedging is a whole other episode. But there's a price that you have to pay to the exchange for every contract that you want to hedge. It's a deposit and you don't get it back until you close the hedge, which is what we do when we sell it. And for a container of coffee, it's about $7,000 right now. Up from $1,500 a few years ago, just because of the high price. And then if you have a 20 cent trading day, like we have been having lots of, which is massive volatility… If you have a 20 cent trading day and it ends 20 cents up the end of the day, the exchange knocks on the door and says, “you owe me another thousand dollars for every contract you have. And we need it tonight.” So, you have to have this pile of capital sitting there available to make your margin calls. If you want to keep your coffee hedged.

MIKE: And that's all that money's doing is sitting there waiting.

ROB: Sitting there waiting and you get it back when you close the hedge button and you don't close the hedge until you sell it. And so, we've got tariffs. We've got hedging costs We've got the high market. We have the inverted market, which we talked about in the last episode which is adding, right now, 25 cents of cost to importers for holding coffee. So, that's another huge amount of money that's basically having to be paid through fees to the exchange to roll contracts. You've got… we're in a high-interest-rate environment, so using money is costing more money. And freight rates are not going down. As a matter of fact, they're going up. And the time it takes to get things from one place to another, the transit times are higher, which means more time that your product is tied up with your money.

MIKE: Why is that real quick?

ROB: Well, there's the Red Sea issue. So, coffee's having to go around… coffee from Africa is going around Africa instead of through the Red Sea.

Just in general, trade with China has created a sucking sound for containers, just, its ports are backed up. General infrastructure for shipping right now is terrible. It's just not good. So we've got all of these things happening all at once. Usually in my career, I've never had to deal with more than one of these things at one time. So, we have all these things happening and if you stack those on top of each other in terms of costs that are being associated with coffee, suddenly you've more than doubled and sometimes 3x your whole cost structure. Your money hasn't your available supply of money has not really increased anywhere near that rate and everyone's turning their pockets out. So, I don't have the money to buy more coffee until I get rid of the coffee that I have and that is why roasters are probably feeling the pressure from their suppliers… Take your coffee quicker. Take it now, pay me on time, all these things that are, “hey, what's with the hard case, right?” That's what it is. There's this huge pressure on how much coffee is available that an importer can buy versus how much money they have to buy it. And if you look at what's going on right now with the Brazil tariffs, nobody's bringing Brazils in, importers want to pivot. They want to have coffees available for their roasters. In order to have coffee available, they have to have money available. They run up against their credit limit, just like a roaster can, and the bank says, “you don't get it anymore.” So then they have to say, well, if I wanna buy these Central American coffees and have them ready for next crop, or I want to buy these African coffees now to be Brazil replacements, I need money. And where do they get it? They get it from releasing the coffee that they already have. And that's why you're seeing some importers exit the market. That's why you're seeing some importers dropping prices on inventory, you're like, “what's with the fire sale?” Fire sale is I need to free up my money. And it's crazy. There's a lot of things going on.

MIKE: So, tight supply, tight credit.

ROB: Tight supply, tight credit, and people in the importing community want to do what they're doing just as much as roasters want to do what they're doing. They exist to buy and sell coffee and trade. And if they can't trade, what good are they? So, that's really where the beginning of the crisis is for the roasting community, because if the importers are in crisis, then they don't have credit to extend to roasters.

MIKE: Earlier you mentioned the EUDR. I always want to come back to that because, just personally, I got excited that we might be seeing more African coffees. Right. Is that still the case?

ROB: It's a mixed blessing right so for the roasters in Europe, they know that come end of the year, yhey are going to need to have coffees that comply with the EU regulation, in order to comply with the EUDR regulation, there's a lot of technical things that need to happen and it's made sort of Central America and South America more able to comply than a lot of the African countries, so the coffees from Africa are more likely to come to the US. With the Brazil tariffs, they're even more likely to come to the US. Those are longer transit times. Those are potentially more expensive or not good quality fits, depending on what people were using the coffee for. There's going to be a lot of transition. If you're Dunkin Donuts or you're a Maxwell House, it's not the easiest thing in the world to go from Brazil to Uganda. So, there's going to be this period of like, let's figure out what it is that we need to do. It's going to be messy.

Meanwhile, importers in Europe are saying the regulation doesn't apply until December 31st. Any coffee I have here before that is grandfathered in. So, they're taking all the coffees that they can and moving them to Europe. So, US is trying to get coffee, Europe's trying to get coffee, and they're trying to get coffee, we're both trying to get coffee from the same place at times. So that's not helping with prices or differentials or with logistics. So it's a yet another complicating factor in what's going on.

So, I wanted to have this conversation because I can imagine if you're a roaster and you're just watching prices just go up and up and up and up through the roof at a rate that just is astonishing, especially if you've been in the business for more than five, six years, you would be very mad, right? I would be mad if I was in that position. You're just saying, what is going on with the gouging and the just killing me kind of thing. And I'm in this position where I actually see all the factors stacking up. So, I felt like I wanted to have this conversation to say, here's what they all are and some of them are things that might go away over time. And some of them might take longer to go away. And some of them might never go away. And so, because I want people to understand where they're going to have to adjust their cost structure versus where they can just wait it out. So, I would go back to the same advice that I had in our last episode, which is to simplify, first of all, because if you are trying to spread your business over lots of different transactions, you're just, you're not maximizing your scale. But, I would also say for this, that protecting your credit lines is a huge one. Right? So, if you're looking at, you have say four or five suppliers and each one of them has given you a credit line, plus maybe you have a line of credit with the bank, those are probably the biggest business assets you have right now in this environment. Because if you lose those, it's going to be really tough to operate. So, communication is a huge thing. I have a guy who gives us sort of like market news every day. And he's very quotable. His name's Mike Nugent. And a few months ago, he sent one where his headline was, “Take your banker to lunch.” It's usually the other way around. It's usually a banker that takes you to lunch. It's take your banker to lunch. And I think that that's pretty wise advice, especially in this environment where it's, everyone wants to ask for additional credit. It's more like, I keep the one that I have? Yeah. Right. Is because without it, man, it's going to be tough.

MIKE: So should they take us to lunch? Because traditionally we've been the banker.

ROB: You know, I like to eat, but no, that's it's not a solicitation for lunch. I think that it's more of what does it take to be seen as a good credit risk. And it's it's two things. It's of course it's paying your bills, but it's also communication. I mean, because everyone's in tough times and there are things that are happening and people are, you know, your customer doesn't pay their bills, suddenly you don't have the money. Now you can't pay your bill. That's where communication comes in. Sure. You know, because the people who are having that conversation proactively are gonna be seen as sort of, a better bet than those that just go dark.

MIKE: Right, well we can't plan on silence. Sorry to say, but if you're habitually a slow payer, it's not the best for you.

ROB: Yeah and especially if you think, that was another reason why I wanted to sort of have this conversation, is especially if you think just the fat cats are getting rich here. I think that right now everyone's in trouble. I I do think that if you're one of those sort of wait-it-out kind of people I would expect it to last a bit of time and possibly get worse before it gets better

MIKE: Yeah, maybe three and a half years or so.

ROB: That's possible, but I think the specific things that are happening in coffee, tariff relief will be a huge one, but also just the normalization of supply and demand, and these things take time. You know, coffee has to arrive in the right place and everyone has to feel like they have choices and that makes the prices come down. It's not just, “I saw a news report that there's going to be a big crop next year and everything” it should work that way, but it doesn't.

And especially how long it takes to get things from place to place. We have issues with macroanomics in both Europe and in the US. We have wars and inflation and all… It makes this very sort of murky picture on demand. The market will stay high as long as that level of uncertainty persists. And we have a lot of uncertainty right now, which again, which is why I want to have these conversations because. it's uncertainty, but at least we can define what's making up the uncertainty. So, we can watch those factors individually and go, okay, that's getting better, this one's getting worse. We can put some context to the craziness.

MIKE: It's hard for us to understand, and this has happened before in the history of coffee when prices were high, even when there's congressional investigations, in the 70s and the early 50s. And the investigators, what they couldn't understand is they couldn't find the person or the people who were getting rich. So who's getting rich this time?

ROB: Right, well, and that's a good question. I think that it's easy to say it's the producer, and certainly, what we're seeing is producers sort of holding back coffee and saying, “well, every time I wake up, the market's higher, so it doesn't feel like today's the day. I think I'll sell when the market's, I feel like it's got nowhere to go but down. That's the day to sell.” Now, producers historically get that mostly wrong, just like roasters mostly think it can't go any lower, and then it does. I think that to say that the producers are getting rich is a little facile. They're not, first of all, most of them are in multi-generational debt and their costs have gone up just as much as ours have.

MIKE: If there was a congressional investigation, which obviously there won't be, they would come to the same conclusion. They can't find the smoking gun.

ROB: Yeah, and the other thing that's worth thinking of is that risk is priced into cost. Whoever's taking the most risk will charge a premium for that. And so, that's worth considering as you're negotiating prices, is who's taking the biggest risk. And if you're holding a product for a long period of time in a very volatile environment, you're taking a lot of risk. And it's sort of the same as if you are a roaster and you're going to give a one year quote in wholesale to a customer. Right? Man, there's a lot of time between now and then where things could change.

MIKE: Yeah, don't do that now.

ROB: Yeah, please don't. Batten down the hatches, simplify, and communicate to all your stakeholders, internal and external.

MIKE: Please, please do. You gave me some notes about your thoughts on this before we started earlier today, and you ended saying we're here when you need us.

ROB: Yes, we are. So give us a call. I'd love to hear what it is that you'd like me to talk about. So please feel free to email in or…

MIKE: Yeah, I'll give out the email at the end here after we're done and we have a little survey online, a place that you can go and put your questions.

ROB: If I was Mark, I would say you should call us, but we're not live.