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Sunday, Apr 14, 2002

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Coffee: Brewing still

Reshma Krishnan

It has been a tepid two years for coffee. Prices are at their 30-year low, the retention plan has failed, and Brazil's production is set to increase in 2002-03.

India's coffee production in October - November 2001 was 19,216 tonnes, 13.6 per cent lower than the 22,227-tonne output during the corresponding previous period. Production declined in 2001. Reduced supplies should push up prices. However, because of stagnating consumption, prices have remained depressed for over two years.

Prices of all varieties have fallen for seven consecutive months compared to the corresponding previous period. The price of Arabica Cherry AB fell 27 per cent to Rs 1,774 for 50 kg in October - December 2001. This decline comes on top of a 17.9 per cent fall during the corresponding previous period. Plantation A prices fell by over 25 per cent to Rs 2,688 per 50 kg. To get a clearer picture, compare the 2001 prices to that in1999. In 2001, prices were 32.8 per cent lower than the October - December 1999 levels of Rs 4000 per 50 kg.

Robusta Parchment AB has seen the biggest fall. Usually grown in big plantations and used mainly for instant coffee, it. has usually traded at a premium to Robusta Cherry. But intense competition from smaller plantations forced a sharp price cut on the Parchment growers. As the Tata Coffee managing director, Mr M. H. Ashraff says, "The coffee industry is going through one of its worst times. If the price of coffee is compared in dollar terms then the current levels are lower than what they were a hundred years ago!"

International coffee prices have also been weak The average export price of the Arabica variety has fallen 43 per cent from Rs106 per kg in October - December 1999 to Rs 60 in October - December 2001. Export prices are extremely important to the Indian coffee market as 80 per cent of the production is exported. Also, as India mostly exports Robusta, the steep fall in prices has really hurt realisations. So even while export volumes are up, margins are shrinking rapidly.

India's export realisations have been depressed for two years now. The export volumes for the coffee season October to September 2001 were actually up 15.63 per cent to 1.95 lakh tonnes. However, the unit realisation was down 16.21 per cent; in rupee terms down 3.11 per cent to Rs 1,170.67 crore. The US, Russia, Italy, Germany and Belgium accounted for 62 per cent of India's exports in 2000-01; the realisation was the highest from Russia. The lacklustre exports have hurt such major players as Tata Coffee that depend greatly on foreign markets. Tata Coffee's exports fell 14 per cent for quarter ending December 2001 and margins also shrank considerably.

So what is the problem?

The problem is a result of higher production and larger carryover creating stockpiles of coffee. Leaders Brazil and Columbia controlled much of the world coffee production. Problems began when Vietnam emerged as the second largest producer, after Brazil, in the last 7-8 years and also became the biggest producer of the cheaper Robusta variety. In the same period, large-scale replanting led to increased crop yields in Brazil. World coffee production was up 3.4 per cent in 2000-01 at 7,046 million kg. Consumption, however, did not keep pace.

To combat this unabated fall, the ACPC (Association of Coffee Producing Countries) scheduled a series of meetings to work out plans for a retention programme that they hoped would lift the sagging prices. In June 2001, the plan was set in motion and most countries supported the ACPC scheme that was to involve retaining 20 per cent of world exports until prices sustained at a particular level. This plan failed miserably with most countries such as Vietnam unable to curtail exports. According to Mr Ashraff, "The coffee retention scheme initiated by the ACPC was bound to fail. No cartel, including the OPEC, has managed to sustain prices. The answer lies in reducing production and increasing consumption globally"

This is easier said than done. Next year, the production is expected to rise on the back of good weather conditions in Brazil. It is expected to go up in the 2002-03 season by almost 41 per cent. Brazil will produce between 37.6-39.6 million bags (one bag = 60 kg), up from 28.1 million bags. This will affect international prices. Most other countries will see a fall in production mainly because of bad management of crop in the last two years.

India's coffee production is likely to be hit the next crop year (October 2002-September 2003) also because of the poor agricultural management practices arising out of lower prices for the produce. The crop may be lower than the revised projection of 3.06 lakh tonnes even this season. Production is likely to be hit due to poor yield — fertiliser and pesticide offtake has been lower. Growers in Karnataka, which accounts for about 70 per cent of the country's coffee production, say the fertiliser offtake has declined by 25-40 per cent. Labour input has also reduced by about 20 per cent as there is not enough money to pay workers.

India's main problem is the overproduction of the cheaper and hardier Robustas mainly by Vietnam, and impacts its the export realisations the most. The big question, according to the industry, is if large roasters will maintain quality by favouring Arabicas and pay a higher price for quality or if they continue to look for profits substituting Robustas.

The only way out for the industry, as Mr. Ashraff pointed out earlier, will be to reduce production. Latin American countries have started to destroy poor quality coffee.

There could be a natural shake out as the coffee crop on thousands of hectares is destroyed. This should result in a drop in production in 2003-04.

Therefore, the 2003-04 coffee season may see a rebound in prices and export realisations. From India's export perspective, Russia is the big market; it is expected to grow 10 per cent as incomes improve.

Given that Russia offers the highest realisations and volumes, this is good news for industry majors such as Tata Coffee whose main markets are the CIS countries and Russia.

Another important development is the move to branded coffee. Branded coffee prices have not fallen as steeply. But even in the branded segment margins are getting squeezed due to the intense competition from the local players.

is, however, the future growth area for any coffee company. Nestle is the leader in the branded coffee segment. Tata Coffee plans to relaunch its brands and increase its exposure to branded coffee. Strategic alliances are another route to growth.

For instance, that between Tata Coffee and Barista. Tata Coffee took a 34 per cent stake in Barista which meant an assured offtake of its produce and a move up the value chain where lie the real profits.

From an investment perspective, coffee will take at least another year before showing positive performance. Only in 2003-04 coffee might see a revival in prices; next year they may stabilise at current levels.

That mainly depends on whether Brazil's crop production projections are correct.

Tata Coffee is a fully integrated company, growing its own coffee and selling through its own brands both in India and abroad. It is also the second largest exporter of instant coffee to Russia.

An investment in Tata Coffee might be rewarding, but after two years. Coffee is a cyclical industry with many uncertainties, and investors should factor that risk in before taking an exposure in the stock.

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