Coffee is the most consumed beverage in the world. It is grown in subtropical and tropical climates. There are two types of coffee
- Robusta: Grown in lower altitude. It has more caffeine and is bitter in taste. Vietnam is the largest producer.
- Arabica: Grown in higher altitude. It has less caffeine and is sweeter in taste. Brazil is the largest producer. Sells at a premium. 75% of the world’s coffee demand is Arabica.
In India, both are grown in the states of Karnataka, Tamilnadu and Kerala. From planting, it takes three to five years before the coffee plant begins bearing cherries. This long gestation period usually creates demand-supply issues.
Coffee cherries are picked from the plant. From that beans are extracted by processing, processing can be done with either dry or wet methods. These extracted beans are also called green coffee.
After that, they are roasted and turned into brown coffee beans. Roasting is done at different temperatures and different types of coffee are produced. Broadly speaking there are 4 popular categories of coffee in the world.
- Spray-dried Coffee: Roasted at 200 degrees, it has less aroma cheap in price. It is powdery and instant.
- Agglomerated Coffee: Made by rehydrating spray-dried coffee. It is in granule form, with 10-15% higher margins than spray-dried coffee.
- Freeze-Dried Coffee: Roasted at a low temperature of 50 degrees in a cold room of -40 degrees. Aroma is retained in the process. This requires costly capex. Higher margins approx 10-20% more than spray-dried coffee.
- Freeze-dried liquid coffee Most expensive Highest margins
Three kinds of players are involved in the coffee business. Farmers, Processors and Retailers. For farmers it’s a commodity business, value addition takes place at the processing and retailing level. Processors like CCL products are in B2B business, Retailers like Nestle, Bru, Starbuck, Tata Coffee are B2C. Tata Coffee is in all verticals they do coffee plantation, processing, and retailing as well.
Among the listed player CCL is the largest coffee processing company. It also has a retail business by the name of continental coffee.
The company buys green coffee, processes it, and sells it to its end clients. 80% revenue comes from B2B business and 20% comes from B2C
CCL buys green coffee as per the advance orders it receives from its customers. Like if Reliance gives the order to CCL , CCL will then buy green coffee, process it and deliver it to Reliance. CCL works on a cost+processing charges model, which helps it to keep its profit margins stable.
Moat factor: The taste of coffee changes with the change in the way of processing. Big brands have customers who like a particular taste of coffee. If the brand changes its suppliers chances are high that there will be a change in the taste as well. This can be risky for the brand as it may lose its customer. For example, people go to Starbucks for a particular taste. If Starbucks starts buying processed coffee from another supplier that taste might change and Starbucks may lose the customer. That’s why Starbucks won’t risk changing the supplier even if the other supplier is offering a discount.
That creates the moat. CCL that’s why has very loyal customers who are with CCL even from 20 years. Moreover, CCL has developed 1000+ different taste coffee and offers customized products for its customers. CCL being a very large processor of Coffee can buy green coffee beans at a discount. That’s what competitors can’t replicate easily.
Risk: The company is trying very hard to build the B2C business with its continental brand. Currently, this is a loss-making business. The company enjoys the competitive advantage in B2B business, but if other players add capacities its realization might take a hit.
Caution/Disclaimer: This Blog on Indian coffee sector is not a recommendation to buy / hold / sell any stock. The published post is for information purpose only. Investors should seek advice of their independent financial advisor prior to taking any investment decision.
Abhishek is an Engineer MBA in Finance and Certified Research Analyst. He is an active trader and investor in the stock market since 2010. Follower of the philosophies of Warren Buffet and Peter Lynch in investing and trend following in trading.