For a food and beverage (F&B) company such as the Kraft Foods Group (NASDAQ:KRFT), the price of agricultural commodities has a major influence on profitability. This is because commodity costs are a major part of an F&B firm’s cost of goods sold (COGS). Rising COGS brings down the company’s gross margins as well as its earnings before interest, taxes, depreciation and amortization (EBITDA), an important measure of profits from the core business activities of a firm. In this article we take a look at the trends in coffee prices, and how they could impact Kraft’s business.
We have a price estimate of $66 For Kraft Foods Group compared to a market price of about $59.
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Kraft markets coffee brands Maxwell House, Gevalia and Yuban through its beverages division. The beverages business is important for Kraft, as it contributes nearly 12% of the company’s value, according to our estimates. Kraft’s beverages business consists mostly of coffee sales, so coffee prices play an important part in determining the costs for this division.
Uncertainty Regarding Supply Leads To Volatile Prices
The price of coffee has seen significant volatility in the last few months. It rose 22% between the last week of September and the first week of October. It then lose these gains in the following four weeks. This was followed by a 10% rise in the middle of November, and has since fallen by 12%, and is currently around $1.76 per pound. 
The major cause of the volatile coffee prices is the uncertainty regarding supply. There was a reduction in coffee supply this year, mostly on account of drought and plant diseases. Central American countries, which produce 10% of the world’s coffee, have been hit simultaneously with droughts and a fungus that has destroyed crops. Countries from this region that have seen a double-digit drop in their Arabica coffee bean exports include Guatemala, El Salvador, Nicaragua and Mexico. A drought in Brazil, which supplies a third of the world’s supply, led to pessimism regarding the coffee supply this year. This negativity has proven to be justified, as Brazil is expecting an 8% reduction in coffee production this year, per the latest reports.  The expectations of reduced supply had led to buyers bidding up the price of coffee.
Precipitation in the coffee-growing regions of Brazil has alleviated the concerns of drought. This has brought back hope that the coffee supply from the country will pick up going forward. This in turn has led to a drop in prices. However, some producers are not willing to sell their produce at the current price, expecting that prices will go up in the near term.  As a consequence, companies such as Kraft are not getting the full benefit of the price drop. Not surprisingly, the reduction in price has not yet been passed on to consumers.
Demand Trend Also A Concern For Roasters
F&B companies are likely still looking to cover expenses incurred due to high coffee prices, leading them to increase prices for their products. The J.M. Smucker Company (NYSE: SJM) raised the price of its single serve K-Cup packs by 8%. Kraft foods followed suit and increased prices by 9%.  Earlier hikes in prices of coffee products were not without consequence. J M Smucker cut its sales outlook for the year, after an earlier price increase impacted sales. Notes: