In the course of 2024, the price of cocoa has doubled, making one of the greatest pleasures we know, chocolate, more expensive. Specifically, in April, the price of cocoa on the New York Stock Exchange reached its historical maximum at $11,500 per ton, then moderated and slightly decreased in the following months. After reaching these historical peaks, prices reversed the trend and fell by 15%, but it seems they will surge again and continue to grow over time after this correction.
Investors recognize that this agricultural commodity has great long-term appeal, despite the price volatility driven by drought and climate change affecting production. According to Bank of America, it is likely that cocoa price volatility will continue in the short term. The uncertainty around supply and its implications for spot and future cocoa contracts is the main topic of discussion with their clients. According to their latest report, cocoa harvests for 2023/2024 are expected to decrease by 25% to 30% in West Africa, a region that represents half of the global supply.
In fact, the situation has even led the government of Côte d’Ivoire to limit the delivery of cocoa supplies during the mid-crop (May-July, approximately 20% of annual production) to companies with local grinding capacity. In this regard, Bank of America analysts consider that price and futures volatility for cocoa will continue until the end of August, when projections for the main 2024/2025 crop become clearer.
Better harvest production could translate into a price increase for final products such as chocolate. Bank of America believes that major cocoa and chocolate brands will increase their prices by double digits to compensate for cocoa inflation during this period, considering a future cocoa price of approximately $6,000 per ton by 2025. “Reflecting cocoa price inflation, the impact of chocolate price increases on volume (elasticity) and mix (shift to more affordable products) will be key. However, the current price waves occur after two years of double-digit price increases, questioning historical elasticity patterns, especially in the U.S. market, which has been weak so far,” Bank of America points out in its report.
According to NielsenIQ data in the U.S., chocolate market sales have been weak so far this year, with volume down approximately 5% (and value up about 1%), clearly showing some cracks on the elasticity side. In BARN’s opinion, the main culprit remains the structure of the U.S. chocolate market, which is overrepresented in the mass market. The low representation of private labels and value brands (4% and 10% of volume, respectively) means there is a limited supply of low-priced products to prevent consumers from “abandoning” the category. In Western Europe, chocolate market sales have been resilient, with volume down about -2% (and value up about +8%). The main strength of the European market, according to BARN, is its more balanced nature compared to the U.S.
In Bank of America’s view, one of the risks for BARN is the possibility that some of its clients might reformulate their recipes to reduce cocoa content, especially in the U.S. market, to limit their own cost inflation. Although BARN has reformulation capabilities, this would be a volume obstacle as it would cannibalize sales or lead to a net revenue loss if not recovered.
As seen in the first half of 2024 results, Barry’s balance sheet is very sensitive to cocoa price movements, predominantly affecting working capital through the margin call on their short cocoa futures (reflecting the forward purchase agreement). Although the pressure on free cash flow will be intense in FY24 (BofAe: CHF -1.4bn), BARN has the necessary liquidity to face it with: 1) CHF 700 million bonds issued on June 10; 2) CHF 730 million bonds issued on May 5, 2024; 3) a CHF 500 million RCF available; and 4) approximately CHF 430 million in cash available in the first half of 2024 results.
Although it may take time to rebalance the supply and demand of cocoa, this will happen eventually, according to the report. Beyond the positive volume elasticity in the chocolate category resulting from a deflationary environment, in our opinion, the key positive for Lindt will be its ability to retain price increases, which will imply a tailwind for gross margin, likely translating into increased spending on advertising and promotion to continue nurturing brand value. Conversely, Bank of America estimates the impact will be less beneficial for BARN beyond the positive elasticity of the category, as prices will mathematically decrease for them considering the cost-plus model structure.
*Harvests begin in October.