position management for roasters
DESCRIPTION
This presentation explores two oft-confused elements of coffee roaster position management: exposure to green coffee market prices, and green coffee inventory management.TRANSCRIPT
Position Management forCoffee Roasters
David JoelsonNCA ConventionMarch, 2014
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?”
2. 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?”
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.”
2. Inventory Management
“Prudent inventory management should not cause extreme price exposure”
Manage risk and inventory separately. They do not overlap
OK Slight Overlap
Differential Mgt.
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
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 Market2004 -- 2008
60
80
100
120
140
160
180
Cen
ts p
er L
b
C Mkt
Guat SHB
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
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
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)
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
Priced Coverage MatrixNew 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
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.
Differential Coverage MatrixColombian 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
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
Priced Coverage
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
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
DisadvantagesInitial & 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)
Tips ToolsTerms
Vendor Managed Inventory (VMI)?
II. Managing Inventory
Inventory Management
Conflicting objectivesEnsure supply
Keep inventory low (cash/quality/leanness)
ChallengesUncertain demand
Forecasts become less accurate at the lowest levels
Long/variable supply line
Tip: Classify Green Types for Inventory ManagementGreen 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
Tip: Weekly supply chain or “S&OP” meetings
Focus on Data Identify & Understand Variances
SalesProductionGreen 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?
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
Benefits & Costs of VMI
Benefits to BuyerOne time cash (reduced inventory)
Less admin effort
Suppliers have increased flexibility
CostsSupplier charge for holding coffee
Premium for delivery timing uncertainty
Reduced competitive bidding