Saturday, April 30, 2011

The Brewing Single-Cup Coffee War

The eye-opening fact for coffee drinkers is that coffee prices are up about 90 percent over the past year and are at 34-year highs.

This dramatic increase in the cost of beans sent the world of coffee shops, along with the likes of Dunkin Donuts and Starbucks for a loop.

In addition to raising prices on a cup of its coffee, Starbucks was forced to raise the price of its packaged coffee by 12 percent.

Management at Starbucks and others know that rising coffee bean prices are threatening their profitability. They can't keep raising the price of a cup of drinkers will eventually say “Enough!”.

So they have hit upon a brilliant solution. One that promises higher profit margins than the companies' branded stores. Firms like Starbucks plan to move into the home, single-cup coffee market in a big way.

Single Cup Future

Two of the major chains – Dunkin' Donuts and Starbucks – are racing to roll out a premium coffee product for home machines that brew single cups.

Dunkin' Donuts says it is the country's biggest coffee merchant. It claims it sells more 1 billion cups from its stores every year. And it believes that its customers are thirsting for its brew at home in the evening too.

So it is the first company to make a deal with Green Mountain Coffee Roasters. Green Mountain makes the nation's most popular single-cup coffee machines, with a 70-80 percent share of the US single-cup market.

Green Mountain's business is built on proprietary technology that merges together home coffee makers and its K-cup pods. The company sells the machines at cost, for as little as $100. It makes its profits on the individual pods, which retail for 60-80 cents each.

The Dunkin' Donuts deal with Green Mountain was announced in February, with the company planning to launch its pods nationwide this summer. This will put it ahead of Starbucks whose deal with Green Mountain calls for an autumn launch.

Both Starbucks and Dunkin' Donuts are betting that US consumers will be attracted by the ease of using single-serve pods. As well as their lack of waste compared with traditional drip coffee machines that make whole pots.

In fact, Starbucks is so confident in its new business that it says it expects its own single-cup packaged coffee business to generate $1 billion of sales in the future.

However, there may be clouds in that coffee. Green Mountain Coffee Roasters is not alone in the industry.

European Competition

In Europe, the coffee pods that are fed into single-cup machines have been popularized by another company. The popular brand is Nespresso, which is owned by the world's largest food company by sales, Nestle. And it is one of Nestle's highest profit margin businesses.

The United States is currently only Nespresso's eighth-biggest market, but has rapidly expanded its presence here. After a slow start, its sales have doubled in the past three years. The company says that advance comes on the back of good products, keen design and canny marketing.

Nestle's has decided to push further into the US market. That is because as Nespresso's chief executive, Richard Girardot, says “we know there is big potential”.

Robust Coffee Business

Despite growing competition, there should be room for everyone to grow in this industry which is in its infancy. Portioned coffee accounts for only about 8 percent of the overall global coffee market. Yet was still worth $2 billion last year and growing fast.

No wonder then that Green Mountain Coffee Roasters trades at a valuation like a high-flying technology company. It trades at 53 times its forecast earnings for the next 12 months.

And like a technology company, its stock rocketed higher by 41 percent on the day last month when Starbucks announced a partnership with it.

The single-cup coffee market should be a winner for all involved for now. As Larry Miller, an analyst at RBC Capital Markets, said “If Starbucks can chop up its packaged coffee business into smaller packets that sell at five times the price, that's great for them.”

And great for their investors if they can pull it off.

Saturday, April 23, 2011

Hollywood's New Business Model

There is a showdown happening in Hollywood.....

No, it's not one from the movie set of a Western film. It is a very real showdown between Hollywood movie studios and the largest cinema chains in the United States. And it threatens to change the way Americans have watched movies for decades.

Hollywood's Pay-TV Deal

The problem started several weeks ago. Four major Hollywood movie studios agreed to make their films available on pay-televison only one or two months after their theatrical release. The four studios involved are: Warner Brothers, Sony Pictures Entertainment, Universal Studios and 20th Century Fox.

The movie studios agreed to release their films on a 'premium video-on-demand' basis with the satellite company, DirecTV. Consumers will have to pay about $30 to see a particular film. The first film to be shown this way is expected to be Liam Neeson's latest hit Unknown.

The studios currently wait up to four months before releasing movies on-demand and on DVD.

Why the change? For a very good reason – profits.

Falling Sales

DVD sales were once Hollywood's biggest cash generator. But now sales of DVDs are in inexorable decline, eaten away by online streaming services.

Meanwhile, another source of revenue for Hollywood – the price of tickets at movie theaters around the country – is also showing signs of slowing. Revenues have remained steady thanks to ticket price increases. But the number of paying customers to watch films in cinemas is falling. It fell close to 10 percent last year, according to

So Hollywood is in search of new revenue sources.

The movie studios are in talks in Netflix and other web streaming operators about making more of their content available for online distribution. Warner Brothers, in fact, recently announced a test with Facebook, making The Dark Knight and several other movies available to stream on the social network.

And now the studios have created the shorter premium video-on-demand release window to squeeze more money out of every movie title.

If the premium video-on-demand window is successful, it could potentially change the economics of the film business. It will create a new revenue stream between a film's theatrical release and its eventual release on DVD and Blu-ray.

However, this new Hollywood business model has angered the owners of the nation's cinema chains. They believe this scheme will erode ticket sales.

Angry Cinema Chains

Nationwide cinema chains, including AMC Entertainment, Regal Entertainment and Cinemark Holdings, are represented by the National Association of Theater Owners.

It recently released a very terse statement. It said it had “repeatedly, publicly and privately, raised concerns and questions about the wisdom of shortening the theatrical release window to address the studios' difficulties in the home market.”

The Association added, “They risk accelerating the already intense need to maximize revenues on every screen opening weekend and driving out films that need time to develop – like many of the recent Academy Award-nominated pictures.”

Now movie theater owners threaten to go beyond just angry words.

They are threatening to withhold movies from screens if the studios proceed with their plan to show movies 'on-demand' in homes less than two months after release.

The chief executive of the Association, John Fithian, said his members would allocate more screens to summer movies released by studios not involved in the 'on-demand' scheme.

This may be bad news for the owners of the four movie studios involved in the plan – Warner owned by Time Warner, Sony, Universal owned by General Electric and Fox owned by News Corporation.

But it may bode well for Paramount Pictures which is owned by Viacom.

Its summer releases – Captain America and Super 8 – are likely to get better slots than summer movies from the other studios such as X-Men: First Class and even the final Harry Potter film.

Theater owners have already begun to scale back the number of promotional trailers they screen based on whether the studios are involved in the video-on-demand plan.

It looks to be an interesting summer for movie goers...hopefully the movies will be as interesting.

Saturday, April 16, 2011

The American Financial Experiment

It was another business as usual week for the stock market this past week.

The US stock market seems to be the only market in the world can never go down. As soon as the Dow Jones dips its toe into negative territory, buyers "magically" appear.

This price action all seems to be part of a grand 'experiment' going on right now in the US financial system.

The experiment is being conducted jointly by politicians and their cohorts at the Federal Reserve. It looks to be aimed at finding out at how stupid the American public really is when it comes to financial matters.

The policy is simple. Print up as much money as you can.

The purpose for the money? Twofold.

First, it allows the Federal Reserve to buy up most of the US Treasuries being issued by the US government. This allows the US not to worry about its exploding debt which foreigners are now reluctant to buy.

Second, the money flows into the stock market and other financial assets. This allows Goldman Sachs and others to continue to enrich themselves by continuing to gamble in the markets using high leverage. Gee, I thought that was what caused the global financial crisis!

Since there is no such thing as a free lunch, someone must be paying the price for this. Yes, someone is - average everyday Americans.

They are paying with a currency - the dollar - that is worth less and less with each passing day.

Here is the key relationship people need to become aware of...since the financial crisis began, the Fed's monetary base (the amount of money it has printed) has tripled.

And since then, the price of oil has tripled.The price of gold has tripled. The price of many other commodities has also tripled.

Gee, isn't that a coincidence? That is just what the Fed wants you to think. Ben Bernanke is using the Curly defense from The Three Stooges - "I'm just a victim of circumstances!"

He claims he has nothing to do with rising commodity prices. He claims that his policy of deliberate money printing and trashing the dollar in order to push up stocks has had no effect on these prices.

Hogwash! He and the Washington politicians just think the American people are too dumb to catch on.

They believe that if the Dow Jones is pushed to say 25,000, people won't notice that a loaf of bread is $25 and gasoline is $50 a gallon.

And maybe they are right. Very few people seem to have caught on so far.

Saturday, April 9, 2011

OPEC Needs Higher Oil Prices

The oil producers' cartel OPEC is making history.

For the first time ever, it will reap $1 trillion in export revenues if crude oil prices remain above $100 a barrel, according to the International Energy Agency. Talk about a gusher!

The IEA believes that Opec will hit that target as oil stays above $100 a barrel this year. It also added that the $1 trillion record will happen in 2011 thanks to both this high price and higher oil production.

This astounding figure again emphasizes the point that oil is the world's most important commodity.....

And its significance will only grow as developing nations, from China to India to Brazil, demand more energy.

Opec and Spare Capacity

The most immediate concern for markets is supply disruptions.

Libya was the world's 12th largest oil exporter, producing about 1.6 million barrels a day of high-quality crude oil. Saudi Arabia and other leading member of the cartel, including Kuwait and the United Arab Emirates, have rushed to offset the shortfall.

But as Saudi Arabia and others boost their production, Opec's spare capacity shrinks. It is now less than 4 million barrels a day.

This is well below the peak of 7 million barrels a day in 2009. However, it is still well above the 500,000 barrels a day of 2004 after Iraq went offline following the US invasion the year earlier.

Still, the cumulative effect of several disruptions in the Middle East could drain all the excess capacity.

The oil market is beginning to see this as a very real possibility as unrest spreads throughout the Middle East and North Africa. Although it must be mentioned that the stock market still seems to be blissfully unaware of such a no-longer-remote possibility.

For instance, there is great unrest currently occurring in Bahrain, Oman, Syria and Yemen. Yes, all of these countries are very small producers of oil. But collectively their oil production amounts to a not insignificant 1.5 million barrels of oil per day.

Even these small oil producers going offline would produce higher oil prices. Part of that reason is the fact that as Opec's spare capacity shrinks, the oil market will demand a bigger and bigger price premium. The premium will be to offset the risk that another big disruption, even a hurricane, will force the system to run at full capacity.

Opec Now Needs Higher Oil Prices

There is another reason higher oil prices are in our future. Governments in the region are set to adopt populist energy policies in order to quell political unrest.

The clearest evidence to date of this populism is the hand-outs and boost to public spending announced by King Abdullah of Saudi Arabia. The increased spending varies from one-off bonuses for public sector workers to the promise of half a million homes at affordable prices.

The policies, at a total cost of $129 billion, are equal to more than half the country's oil revenues last year!

Many veteran oil watchers believe the extra spending will lift Saudi Arabia's oil revenue needs on a percentage basis closer to those of Venezuela and Iran. Both countries are well known oil price 'hawks', always wanting much higher oil prices.

Saudi Arabia is likely to pay for this additional spending by tapping the country's reserves, worth an estimated $450 billion.

Even so, prices will need to average $83 a barrel this year for Saudi Arabia to balance its budget. Only a decade ago, the country achieved that with prices at only $20 a barrel.

Unfortunately for consumers of oil, the trend toward higher oil prices needed by the Saudi government will continue. According to the Institute of International Finance, by 2015 the Saudi government will only be able to balance its budget if oil prices are at $115 a barrel.

Saudi Arabia is not alone either in boosting spending among countries in the region. Other members of the six-nation Gulf Cooperation Council have been announcing similar policies. Kuwait, for example, has proclaimed a one-off bonus of $4000 for each citizen and promised free food staples for more than a year.

This higher social spending will not only put upward pressure on oil prices but will also reduce the funds available for state-owned oil companies to invest in adding future production capacity.

In addition, as governments in the region feel under threat from social unrest, they are extremely unlikely to make cuts in energy subsidies for the public. These subsidies have made fuel cheaper than water in many countries in the region.

These subsidies have led to runaway domestic growth in oil demand. This demand, over the past decade, has dented the region's ability to export oil.

For example, oil demand in Saudi Arabia has doubled over the past 15 years. This transformed the country into one of the world's top 10 consumers of oil.

If the trend continues – which is likely – Saudi Arabia and the Middle East at large will have less and less oil for export each year. Which means higher and higher oil prices for everyone else.

Saturday, April 2, 2011

Libya, Asia and the Price of Oil

Japan managed to knock Libya off the front pages of newspapers for a while. But now the biggest military action against an Arab country since the 2003 Iraq invasion by the United States and its allies has put Libya and the oil markets front and center again.

The oil market is slowly coming to the realization that this may be a long, drawn-out affair which may keep Libyan oil off the market for many months. Worse yet war could damage, either by accident or by deliberate actions by Gaddafi, the country's oil facilities.

Libya's Importance

Libya is the world's 12th largest oil exporter. Before the crisis, it produced 1.58 million barrels of oil per day. But now that flow has slowed to a mere trickle.

The stock market has shrugged its shoulders at this and said “So what? Libya only produces a small fraction of the world's daily output. Saudi Arabia can easily make up for Libya's oil production shortfall.”

It should be noted here that the stock market historically has underestimated the impacts of conflicts involving oil producers in the Middle East. And it looks to be doing so again.

However, Libya producers some of the highest quality, 'sweetest' crude oil on the planet. Its crude oil is easily refined into gasoline and diesel. It is also lower in sulfur, making it cleaner to burn.

The fact that you can't substitute one grade of oil for another easily is being ignored by the market. Most Saudi oil is of a lower quality than Libyan oil. It is 'heavier' and has a higher sulfur content.

So one cannot simply substitute one barrel of Saudi oil for Libyan oil. For example, it takes three barrels of Saudi oil to make as much diesel fuel as Libyan oil.

In addition to these direct, short-term effects of Libya on the oil market, Wall Street also seems to be ignoring some rather important long-term effects. One such effect is occurring in the developing economies of Asia.

China and India Shores Up Their Oil Reserves

As oil prices move higher due to the turmoil in Libya, developing countries across Asia are getting a wake-up call. These countries, led by China and India, are shoring up their strategic oil reserves against the risk of a prolonged supply shock.

China is the world's second-largest oil importer while India is the fifth-largest. Shockingly, the pair lack a large strategic petroleum reserve that can be tapped during an oil supply crisis.

Needless to say, the additional buying of oil from these countries to establish a strategic petroleum reserve could easily propel crude oil prices higher than most on Wall Street expect.

The extra demand will certainly further tighten global oil markets. And it may very well test the limits of spare production capacity among members of the OPEC cartel.

China's thirst for imported oil has grown rapidly. Oil imports as a share of the country's total oil demand grew to 54 per cent in 2010. This is up from 30 per cent in 2002. And remember that during the 1990-91 Gulf War, China was an oil exporter!

The country only began its strategic reserve program in 2006. It completed a first phase 102 million barrel build-up two years later. The second phase of the program will build a further 168 million barrels of reserves by the beginning of next year.

It was expected to finish filling its reserve by 2020. When completed it will hold about 500 million barrels of oil. This is roughly equivalent to three months of imports and will be the second biggest stockpile in the world. The Libyan crisis, it is believed, has only accelerated China's stockpiling of oil.

India is way behind China, holding only about 10 million barrels of oil in stockpiles. But it is even more vulnerable to a supply shock than China. It imports about 80 per cent of its oil consumption.

The country is targeting a reserve of about 40 million barrels by the end of 2012. This is equivalent to only two weeks of imports. But if India were to build up a stockpile of oil similar to China's, it will need to buy from between and 200 million and 250 million barrels of oil over the coming years.

Long-Term Effects

There are two key takeaways for investors from all of this. One is that the additional buying from the emerging economies to build strategic stockpiles will, at the least, put a floor under oil prices. Second is that the added buying may send oil prices much, much higher than many on Wall Street are currently forecasting.

Soozhana Choi, an oil analyst at Deutsche Bank in Singapore, summed up the situation nicely by stating that China's [and India's] strategic stockpiling “is likely to be a feature of of the global oil market not only this year but this decade”.

A feature, I might add, that is not factored in to current stock prices. Such a scenario with much higher oil prices will likely inflate the stocks of oil producers, but deflate most other stocks.