Cocoa rally sweetens Kraft's Cadbury deal

The longest cocoa rally in three decades is ending as growers boost output, widening profit margins for chocolate makers who've already shrunk the size of candy bars and substituted cheaper ingredients to save money.

European stockpiles are five times the 60-month average after bean prices rose 23 percent last year. Top producers Ivory Coast, Ghana and Indonesia may grow 6.6 percent more in the 12 months that started in October. Barry Callebaut AG, the biggest bulk chocolate maker, said the global economic slowdown means it will take until 2012 for unit sales to grow 2 percent or more, the average until last year's 2.6 percent drop.

"Demand is lousy," said Hans-Werner Lembke, the managing director of Hamburg Cocoa and Commodity Office GmbH, a supplier in its namesake German city. "Warehouses in Europe are full of cocoa butter. Consumption this year will be worse than 2009."

Cheaper cocoa will shore up margins in the $80 billion chocolate market and may bolster returns from Kraft Food Inc.'s $19 billion takeover of Cadbury Plc. A 25 percent drop would boost operating profit at Kilchberg, Switzerland-based Lindt & Spruengli AG by 15 percent, said Claudia Lenz, a Bank Vontobel AG analyst in Zurich.

Mars Inc., based in McLean, Virginia, reduced the size of Snickers bars in Australia by 12 percent last year, to 53 grams from 60 grams, without changing the price. Uxbridge, U.K.-based Cadbury used "innovation-driven size reductions" in the third quarter to deliver "significant margin improvement," Chief Executive Officer Todd Stitzer said Oct. 21 on a conference call.

Price ForecastsCocoa futures will tumble 10 percent to average $2,700 a metric ton this year, the first drop since 2005, said Gary Mead, an analyst at VM Group in London. Standard Chartered and the Economist Intelligence Unit see cocoa falling 5 percent and 5.4 percent, respectively, by year end from last week's close of $3,001 in New York.Beans on the ICE Futures U.S. exchange in New York doubled in the past four years, the longest rally since 1978, as output dropped in Ivory Coast, which grows a third of the worldwide crop. Futures touched $3,510 on Dec. 16, the highest since February 1979. On London's Liffe exchange, cocoa sold for the equivalent of $3,449 on Feb. 5 after reaching a 21-year high on Jan. 21.Chocolate makers will raise retail prices as much as 5 percent this year, hurting consumer demand, Joern Iffert, a UBS AG analyst in Zurich, said in a Jan. 6 report.Unit Sales SlowHershey Co.'s unit sales declined by "low-single digits" in the three months ended Dec. 31, after the maker of Kisses and Kit Kat bars raised U.S. prices 8 percent, Chief Executive Officer David J. West said Feb. 2 on a conference call. The Hershey, Pennsylvania-based company has a 45 percent share of the U.S. chocolate market.A 10 percent decline in cocoa costs would lead to a 1 percent increase in operating margins, even without more retail- price increases, Jon Cox, the head of food and beverage research at Kepler Capital Markets in Zurich, said in an e-mail.Kraft, based in Northfield, will acquire a Cadbury chocolate business that spent about 5 percent of its revenue on cocoa last year."We were able to offset input-cost inflation with a successful price-realization strategy," Cadbury Chief Financial Officer Andrew Bonfield said during a Jan. 14 conference call. Even after the rally in cocoa, "we remain confident" that higher prices on selected products will "negate the margin impact of such commodity increases" this year, Bonfield said.Chocolate-Maker SharesAs of Feb. 5, Hershey shares were up 2.4 percent in the past 12 months at $37.35 in New York trading, trailing the 9.1 percent advance of Lindt, which ended last week at 24,670 francs ($23,000) in Zurich, and the 9.4 percent gain for Kraft, the maker of Cheez-Whiz and Oreos, to $28.44. The Standard Poor's 500 Index has gained 26 percent in the same period.Lindt spokeswoman Nina Keller and Kraft's Michael Mitchell declined to comment on cocoa costs. Kirk Saville, a spokesman for Hershey, didn't return calls.In Eastern Europe, demand for chocolate is falling and "still badly suffering" from the recession, while western countries have "stabilized at a low level," Zurich-based Callebaut said Jan. 13 in a statement. "The Americas has bottomed out, but is not recovering yet," the company said. "Asia is showing some early signs of a recovery."Cocoa-Butter SubstitutesConfectioners in Eastern Europe are replacing natural cocoa butter with cheaper substitutes, including cocoa powder, which costs about 25 percent less, said Steven Haws, who produces an industry benchmark price survey as founder of Commodities Risk Analysis LC in Logan, Utah. Lower demand for cocoa butter has cut the price to 1.6 times the cost of the beans, down from the five-year average of 2.6 and the cheapest since July 2002, said Haws, a three-decade industry veteran.Callebaut Chief Executive Officer Juergen Steinemann said that speculators will continue to drive up costs. Hedge funds and money managers had more than six times as many bets that futures would rise as wagers that they would fall as of Feb. 2, up from a ratio of 1.5 in May, Commodities Futures Trading Commission data show."There is a bigger chance that cocoa prices will further rise than that they will fall," Steinemann said Feb. 1 in an interview at the International Sweets and Biscuits Fair in Cologne, Germany. "Hedge funds have been intervening in the cocoa market in the past six months. They don't belong there, and the chocolate customer has to pay the price."Beans may sell for as much as $4,000 by the end of the year, said Daniel McNamara, a senior vice president at cocoa dealer Transmar Commodity Group Ltd. in Morristown, New Jersey.'Whipping Boy'"To blame speculators for the price of cocoa is looking for a whipping boy," McNamara said. "Cocoa generally rebounds with population increases. You have more income in developing countries now. The outlook for cocoa for chocolate consumption can only be viewed in one way: very good."Supplies may be hurt by dry conditions in northern and central Ivory Coast, including its Daloa region, which produces more than 300,000 tons a year, Kona Haque, a commodity analyst for Macquarie Bank Ltd. in London, said in a Jan. 22 report.In the Ivory Coast's southwestern Soubre region, farmer Emmanuel Kouassi N'Gourou used a machete last month to show a visitor how healthy the trunk of one of his cocoa trees was."All the indicators are pointing to a good main harvest," N'Gourou said. "We have treated our farms" with fertilizers, he said. "But in order to sleep well at night, we just need one last big rain before the dry season sets in," he said on Jan. 21. The region's dry season lasts from December to April.Harvest RecoveryIvory Coast supplies will recover from last year's 12 percent slump, helping to pull the global market out of a supply deficit for the first time in four years, said Jan Vingerhoets, the International Cocoa Organization's executive director. Global consumption exceeded production in the 2008-2009 marketing year by 28,000 tons, the smallest imbalance in three years, according to data from the group.The cocoa rally was driven by a global harvest that shrank 5.8 percent to 3.5 million tons in the year that ended Sept. 30, according to the ICCO, whose member countries account for 84 percent of world production and 60 percent of consumption.Ivory Coast, Ghana and Indonesia may produce as much as 2.59 million tons of beans this year, compared with 2.43 million last year, based on estimates from Macquarie's Haque, Ghana's biggest closely held buying company and an Indonesian cocoa- producer group. The three countries accounted for 67 percent of the world crop last year, ICCO data show.Slowing DemandRising production coincides with reduced demand. Processors in the U.S., Canada and Mexico ground 1.5 percent less cocoa in 2009's fourth quarter than a year earlier, the Washington-based National Confectioners Association said Jan. 21.Globally, processing slid 6.6 percent to 3.51 million tons in the 12 months ending with September, the first drop since the 2001-2002 season, according to the ICCO.Traders estimate European warehouses hold 50,000 tons of cocoa butter, compared with an average of 10,000 tons over the past five years, according to Hamburg Cocoa's Lembke and Macquarie analysts. Current stockpiles are the equivalent to 132,000 tons of beans, more than four times the size of last year's deficit.Demand for cocoa butter probably won't recover until prices fall to $5,000 a ton, Haws said. Europe, the world's largest market, started the year at $6,000 a ton and dropped 10 percent to $5,385 as of Feb. 5, he said.Cocoa-powder consumption has begun to slow after prices doubled to more than $4,000, Haws said."High bean costs really squeeze the processors' margins to the point that it's hardly worth their while grinding," Haque said in an e-mail. Chocolate sales are "still obviously reeling from the recession," she said.