Tag: Merchandising

In his book, “The Wisdom of Finance: Discovering Humanity in the World of Risk and Return”, the Harvard Business School professor Mihir Desai compares company mergers with marriages. He writes that both are fraught with difficulties, and warns:

• Due diligence is vital
• Filling a hole in your organization is not a merger strategy
• Racing against the clock leads to bad decision-making
• Synergies are always overstated
• The costs of integration are always understated
• Asymmetric mergers are easy but of limited value, and mergers of equals are horribly difficult but potentially very rewarding
• Serial acquirers are problematic
• Ultimately, it’s all about culture, “doing the work”, and execution. As Thomas Edison once said, “Vision without execution is hallucination”.

This past week brought news reports that ADM’s projected acquisition of Bunge is progressing faster than expected, and that an announcement could be soon.

ADM has revenues of $62.3 billion and a market value of $23 billion; Bunge has revenues of $42.7 billion and market value of $11 billion. ADM is the most U.S.-focused of the major grain companies and a takeover of Bunge would help it grow in South America, where Bunge is the largest exporter in the agriculture market, posting revenues of 40 billion reais or almost $13 billion.

Bunge is not only a big agricultural exporter from South America; it is also a big producer in the region, most notably of sugar and ethanol. The company owns and operates eight sugarcane-crushing mills in Brazil with a combined capacity of over 20 million tonnes, making Bunge the third biggest producer after Raízen Energia, which is backed by  Cosan and Royal Dutch Shell, and Biosev, a subsidiary of Louis Dreyfus.

The FT once described the sugarcane mills as “a financial millstone for Bunge”, although the mills are now expected to report an annual operating profit of $75m .

In November 2017 Bunge announced that it was in the process of separating the finances of its sugarcane unit from the rest of the company as part of an effort to reduce its exposure to the operations, and was considering selling the unit in an IPO. An analyst at the time valued the unit at between $1 billion and $2 billion.

Also last week, soda-seller Dr Pepper Snapple Group and coffee maker Keurig Green Mountain (owned by serial acquirer Luxembourg-based JAB Holding Co) announced that they were joining forces to create a beverage company with $11 billion in annual revenue. The combined company will be called Keurig Dr Pepper, or KDP, and is targeting $600 million in synergies on an annualised basis by 2021. Keurig’s CEO said,

“Our view of the industry through the lens of consumer needs, versus traditional manufacturer-defined segments, unlocks the opportunity to combine hot and cold beverages and create a platform to increase exposure to high-growth formats. The combination of Dr Pepper Snapple and Keurig will create a new scale beverage company which addresses today’s consumer needs, with a powerful platform of consumer brands and an unparalleled distribution capability to reach virtually every consumer, everywhere.”

I have quoted that statement in full because it highlights the most important market shifts in recent decades: the transfer of power from the producer to the consumer. It also highlights the importance of distribution networks, getting products in front of consumers.

Both Keurig’s acquisition of Dr Pepper and ADM’s possible acquisition of Bunge have one thing in common: a heavy sugar component. Some analysts questioned whether Keurig’s move into soda was the right one given the trend away from sugar and sugar-containing sodas. Sales of soda drinks decreased about 1.2 percent in the United States in 2016, falling for the 12th year in a row.

One analyst wrote that from Dr Pepper’s perspective,  the merger “makes a lot of sense…they needed to diversify their business line from sugary drinks, so I think that this is a really good deal.” Bulking up is a way to boost efficiency in the business at a time when soft drink sales are falling as consumers cut down on sugar. “If your truck is becoming less full because volumes are declining, you should have other beverages to fill that spot,” he added.

Just last week a survey was published that found that most Americans now believe that sugar is more harmful to health than marijuana. The Wall Street Journal/NBC News survey found people rank cigarettes, alcohol, marijuana and sugar in that order in terms of harmfulness. A surprising 21% of respondents said that sugar was the most harmful of the four.

So what are Keurig and ADM doing buying into the sugar business? Is, as one analyst suggests, Keurig just buying empty space on Dr Pepper’s fleet of delivery trucks? And does ADM really want to buy Bunge’s sugar mills, or do they have no choice in that they are being thrown in as part of a take-it-or-leave-it package deal?

Or are both companies betting that the anti-sugar trend has over-extended itself and is about to correct? Although there is little evidence in the media to that effect, a recent study found that sugar taxes do little to reduce sugar consumption, and that even if they did the resulting reduced sugar consumption would have little meaningful impact on health.

At some stage or another, people will eventually realise that sugar is not the cause of the obesity epidemic, and that cutting sugar consumption is not the silver bullet that many people expect it to be.

As such, ADM and Keurig should probably worry less about the sugar components of their deals, and more about the other potential difficulties that Professor Desai warns about in his book.

We all depend on the big agricultural commodity merchants for much of the food that we eat and the clothes that we wear. Merchants move vast quantities of food and fibre from producers to consumers, from surplus areas to deficit areas. Without merchants, crops would rot in the fields, farmers would go out of business, and people would go hungry.

However we cannot take it for granted that commodity merchants will be able to meet the challenges that lie ahead. The sector is under pressure from all sides and its future is far from assured. With world population expected to reach 9.7 billion in 2050, that is a major issue that needs addressing.

Some of you may argue that these pressures are temporary; that commodity merchandising is a cyclical business; and that we are just in one of the down cycles. And you will be partly right. World food stocks are at an all time record, resulting in higher storage costs, compressed margins and reduced price volatility—all bad news for merchants.

However most of the sector’s current problems are not cyclical but structural. The ten most challenging issues for agricultural commodity merchants are (probably) as follows:

1. Both the spread and the speed of information have increased dramatically, leading to better and more quickly informed clients, reduced price differentials and lower or negative trading margins.
2. There has been a shift of market power along the supply chain, initially from farmer to trader, then to distributor and retailer, and now to the end consumer. Social media in particular has empowered consumers at the expense of producers and traders.
3. This shift in power has focused attention on where food comes from, and what damage it may have caused both environmentally and socially on its way.
4. This focus on social and environmental sustainability has increased costs (e.g. certification) for producers and traders.
5. It has also led to a shift from tradability to traceability. Being less able to trade origins reduces merchants’ flexibility and profits. It can also increase costs if products have to be kept separate. Traceability is turning many commodities into ingredients.
6. A greater focus by consumers on their own health can result in difficult to predict—and fast moving—trends. Sugar and fruit juice are examples, as is the pushback against GMO products in the US.
7. Empowered consumers result in increased government intervention, whether in areas of health and safety, or in trade relations. Consumer trends can quickly change direction, and governments are rarely far behind. This increases merchants’ risks and pushes up their compliance burden.
8. Increased consumer empowerment has been accompanied by the media’s increased hostility to agricultural merchants. This media hostility has reduced merchants’ political leverage, and made it harder for them to hire talent.
9. At the same time, advances in Artificial Intelligence mean that computers are now better than humans at trading futures markets. As a result, agricultural commodity merchants are less able to leverage the insight that they glean from merchandising physical commodities into trading futures markets.
10. Global climate change may increasingly make both crops and trade flows less predictable, increasing the risk when investing in infrastructure such as warehouses and port terminals.

Many of the trends listed above are “good things”. Empowered consumers, supported by fast-moving and attentive governments, are leading to changes for the better in terms of environmental and social sustainability, and health.

Agricultural commodity merchants should not try to resist or reverse these trends, but embrace them. The sector knows that if it is to survive it has to adapt and evolve. But how?

One thing that the sector can—and must—do is to improve its public image. Physical commodity merchants, rather than being seen for the good that they do, are perceived as evil speculators, accused of pushing food prices higher, creating shortages and hunger.

As a sector, we have to explain to the world what we do, to show the public that we are under the same pressures and constraints—and have the same challenges—as everyone else. And we must also explain that we are not perfect, that there is still progress to be made—and that we are trying to make that progress.

The first objective of our seminar in London in June therefore will be to discuss how we can adapt and evolve to survive: hence the choice of London’s Natural History Museum as the location for the meeting.

The second objective of our seminar in London will be to show the world that agricultural commodity merchants are human beings like everyone else. We have families; we live in communities; and we care deeply about our planet and the wellbeing of its inhabitants.

Charles Darwin once wrote, “In the long history of humankind, those who learned to collaborate and improvise most effectively have prevailed”.

Last week it was reported that ADM has approached its rival Bunge about a potential takeover, eight months after Glencore proposed doing the same thing. Last summer Bunge’s CEO suggested that his company might be worth more as part of a larger organisation. Bunge, according to the FT, « has no poison pill or bylaws that would allow it to fend off an unsolicited approach, making it vulnerable to a hostile takeover ».

It is unclear how Bunge, with a market capitalisation of about $11bn compared to ADM’s $23bn, reacted to the ADM’s approach. It is also unclear how the deal might fare under US antitrust laws; the combined entity may to have to divest significant assets, especially in the US and Canada.

Meanwhile some analysts predicted that Glencore would enter into a bidding war for Bunge; others suggested that Glencore would sit back and pick up the assets that ADM might have to divest, particularly its North American grain silos and processing plants.

The offer for Bunge goes against ADM’s (apparent) strategy of diversifying away from low-margin and volatile commodities into higher-margin and more stable ingredients. In 2014, ADM bought natural the ingredient company Wild Flavors for about $3 billion, and has since also expanded into other « healthy » ingredients such as fruits and nuts.

Last week also saw Ferrero announcing a $2.8bn cash deal to buy Nestlé’s US confectionary brands, and so become the world’s third-largest seller of confectionery, behind Mars and Hershey. The FT suggested that the privately owned Ferrero was well placed to pay a premium to expand its confectionary footprint in the US at a time when publicly owned companies are under pressure over concerns about obesity.

However, some analysts warned that Ferrero would face a challenge in managing the move from a company with a small and carefully chosen premium portfolio of products to a multi-brand conglomerate more like Unilever or Nestlé.

Amazon’s $13.7 billion acquisition of Whole Foods last June was also in the news last week. The conventional wisdom at the time of the acquisition was that Amazon would slash prices, expand delivery services and pressure margins across the industry. So far at least, that hasn’t happened, for three reasons.

First, even with Whole Foods, Amazon’s annual grocery sales are tiny compared to industry giants like Walmart and Costco—with roughly 2% share of the U.S. grocery market. It is tough to transform a market with so small a market share.

Second, the deal was forged out of weakness rather than strength; both Whole Foods and Amazon Fresh were struggling before the acquisition.

Third, as an online retailer, Amazon lacks expertise in brick-and-mortar operations; it doesn’t have a model that it can stamp on to Whole Foods. As such, there seem few synergies between the two companies.

However, Amazon is known for playing a long game, and they may have technological disruption on their side. This week the company opened their first “Checkout-free” Amazon Go grocery store in Seattle. The store uses cameras and electronic sensors to identify customers and track the items they select. Purchases are billed to customers’ credit cards when they leave the store. As yet the company has no plans to introduce the technology to its Whole Foods stores.

But technological disruption is not just occurring at the retail end of the food supply chain. This week Dreyfus reported that they had teamed up with their banks to do their first agricultural commodity trade using blockchain technology–a cargo of US soybeans to China. Dreyfus said that document processing on the transaction was reduced to a fifth of the time it would normally take, and that the process reduced the risk of fraud and human error.

As such, the two (maybe three) mergers mentioned above are occurring at a time of rapid technological change–a time when the whole supply chain is being disrupted.

But what else do they have in common, and what lessons can be learned from them?

Mergers are tough to implement and quite often end up destroying value, as well as diverting management time from internal growth. Mergers are even tougher in struggling sectors: two struggling companies do not make a strong one. In addition, it is not necessarily a good idea to go into a merger from a position of weakness. Lastly, just because a company is successful at running one business, it doesn’t mean that it can be just as successful in another, even adjacent, business.

On the positive side it has become clear that companies are better at managing some businesses than others. Confectionary companies are, for example, better at managing brands than they are at managing commodity sourcing and processing. At the same time, too diverse a portfolio of businesses can put strains on management processes.

This could be particularly the case if ADM, an increasingly ingredients-focused company, expands its footprint further into traditional commodity merchandising.

One obvious solution would be for ADM to take Bunge’s more value-added downstream businesses, while Glencore would buy the commodity merchandising businesses.

It will be interesting to see how this one develops.

 

Robert Kuok’s memoirs have been released this week in Malaysia, and six extracts have been published in The South China Morning Post. The first can be found here. The book is not yet available on Amazon

Born in October 1923 in Johor Baru Malaysia, Robert Kuok (or RK as he is known) is a major figure in the world of sugar and has been nicknamed “The King of Sugar”. He has been an extraordinarily successful businessman and apart from sugar and commodities (Wilmar), he is best known as the founder of the Shangri La Hotel chain. Like many successful Asian businessmen, he is media-shy and rarely gives interviews.

I had the honour and the pleasure to converse with RK over three days in 2015. I published a small part of that conversation in my book The Sugar Casino. The Financial Times in turn published some extracts. If you haven’t yet read my book The Sugar Casino (shame on you), here is a taster:

RK welcomed me and apologised for his terrible cold and cough. He had caught it on a recent trip to London where he had been visiting the latest addition to his hotel chain, the Shangri La in the Shard Building. I started by trying to explain my book project but he seemed distracted by his telephone.

“I see I have four messages but I don’t know if they are important”, he said. “Ah yes, last night’s sugar market close.”

“You are not still trading the sugar market?” I asked, astonished.

“I watch the market every day” he replied. “I started in 1955 and this “topping up” takes seconds; if I stop I can never get on to it again. I still trade the sugar market for my claret money; so that I can afford Petrus 1989. Otherwise you would be mad to buy it. But if you are winning at the sugar casino; then why not continue? And the days I lose money, I look sadly at my wine and I tell myself, “Tonight you don’t deserve it”. I open the bottle and drink only one glass as a punishment to myself for trading badly.”

I did a quick sum in my head. RK had started in the Rice Department with Mitsubishi in 1942, the year the Japanese Army occupied Singapore and Malaya. That meant that he had been in the commodity markets for 72 years and trading sugar for 60 years; that had to be a record. I shared my mental arithmetic with him and he smiled.

“Have the markets changed much since you first started?” I asked.

“No,” he replied. “The change has mainly been the speed of information dissemination or gathering, but you have to adapt to that. So my trading volume today is one per cent of what it was. I used to trade 4,000 lots (200,000 tons) in one go; now I trade 40 lots (2,000 tons). Today I am 40 lots long, but my trading pays for the Petrus!” he said with a laugh.

“In early autumn 1963 the sugar market went against you and you almost went broke,” I prompted.

“I had enough cash, thank God, to meet margins. In the autumn of 1963 Hurricane Flora hit Cuba and the market rallied; I was saved. August that year was very difficult. But somehow I can always manage. I was 40 years old and at my best. Although it worried me I never felt like jumping off a building. Still, the position was large for me, maybe 250,000 tons of sugar, part physical sugar and part futures – a huge position for me. Anyway the market turned around. I took some profit and then more profit.”

“How did you know when to take profits?” I asked. “I find the biggest difficulty about trading is knowing when to take profits”.

“Not knowing when to take a profit is the Achilles’ heel for a trader. Take profits! Don’t wait. If you have a profit you have to take it. If you wait it will be your downfall. Also, have the wisdom to realise that you can’t take it in one go or you destroy the market for the balance. If you are a big trader it takes ten, twenty, thirty days to unload, depending on how big your footstep is.

“If you are a big trader you had better start even if you are in minus territory if the market is going up. You are long and you have been suffering: a big minus, a small minus, and then a negligible minus. At that point start liquidating. Even if you sell only 3% you still have 97% to go. You have to shed weight. Waiting to take profits is dangerous.

“What about taking losses?” I asked.

“Well,” RK replied with a sigh. “It is wonderful to take losses when you have profits under your belt. So you need some luck to build up some profits first. You have to start on the right leg. And everything, including quantity must be according to your size.

“In 1963 I took a big position,” he continued. “I was very confident. I felt that sugar was worth more than it was.

“But you know with sugar there is always over production. It is like my hotel business. I don’t know why I go into feast and famine businesses. As soon as you make money in hotels every Dick, Tom and Harry builds a hotel and then there is oversupply. And then you all cry for seven to eight years before you start to make a bit of money.

“The early 1960s were wonderful for me in the sugar market. I was hunting in a lake just teeming with salmon trout. There were only three or five predators; these sharks could eat their fill. I would swim past them and they weren’t even interested in me. Today you go to the same lake: there are giant crocodiles, giant sharks. There is not enough fish to feed these giant predators. You have to think twice before swimming in the lake.

“A lot of traders are arrogant”, I ventured. “They have big positions and have to convince themselves that they are right and therefore have to convince other people that they are right.”

“You have to be humble because you are never always right. You don’t need to convince anyone. You can trade as a very humble man.”

“Is speculation and risk taking an integral part of all life?” I asked.

“An emphatic yes!” RK replied. “When you get into your car and leave your home you are taking a risk. In the modern world there is no back-to-back trading where you can make a simple margin on a physical sugar transaction. Those days are long gone. Those opportunities when they come are like golfing holes in one. I have been playing golf since 1947 and I have never scored a hole in one. So where there is no back to back trading it means you have to lift a leg: you have to sell before you buy or buy before you sell. You have to take a risk. But you can still make good money trading.”

“Are you a businessman who started as a trader or are you a trader who applied your trading skills to business?” I asked.

“I have been asking myself that question for the past 50 years. Let’s take soccer as a parallel. You can train someone to play football but you never produce a Pele, a Ronaldo or a Messi. You have to have natural verve. We are not born equal. You either have that attribute in you, call it genius if you like, but of course different degrees of genius, and then circumstance or fate gives you the playground to exercise your skills. If you are born in the wrong community and your parents force you into the armed forces, well then how do you become a trader? But traders are born, not taught.”

“Footballers often have particular styles, as do traders”, I prompted. “What is your style?”

“When you play poker the secret is to never let the other players guess your next move. I can play a contrarian game but I can also flow with the current. I even involve superstition. In my early days I would look at a fellow trader to see if he had a lucky glow on his forehead. If he did I would spend more time with him that day.”

“Commodity trading is based on trust,” I said. “You have to start a relationship offering trust. But what do you do when someone abuses that trust?”

“Well that is just too bad. You just have to cut your losses; you have no other choice. If you want, you can keep that person as a friend but do so at arm’s length; no more business dealings. But it is better to just cut the cord and part company. If you bear a grudge you are just hurting yourself; you are not hurting the other person. It is like throwing good money after bad. Keep your wits, keep your humour and if you are a good man, luck will come your way again. You will see another opportunity and you will grasp it. I have always believed that.

“But business is about taking and not just giving. I came up the hard school. In an arena where no holds are barred you have to win. Giving is for my charity side.

“I have a simple motto in life: everything single material thing that I have in life can be traded. It is for sale. It is a question of, when, where, to whom and price. The first three are more important. If you like a person the price becomes unimportant.

“Business is quite a game but at the end you want to use your money to help those that need help. We have a very good charitable foundation that is opening the darkened skies above a little more than thirty poor and backward villages in China and adding.”

“Finally, Robert,” I asked. “What advice would you give to someone starting out in business today?

“I would tell them to go east and make their fortune. What you are seeing in China is still only the beginning.”

 

Good morning Swithun, could you tell us a little bit about your company Solaris?

We are essentially focused on milling wheat and corn. For the past two seasons Solaris has been the largest trader of Russian corn. Compared to Ukraine, Russia is not a big exporter of corn; this season Russia will export just over five million tonnes compared to Ukraine with eighteen million.

However, Russia is a powerhouse for wheat. It was the largest exporter of wheat in the world last season. Russia is a veritable focal point for wheat prices worldwide. People really look to see the price at which Russian 12.5 percent protein wheat is trading to help them set wheat prices in other parts of the world.

We did a large programme of corn into Asia last year, namely South Korea and Vietnam. Russian corn has a huge competitive advantage in terms of quality. There is a smaller percentage of damaged kernels (often under 2% as opposed to the contractual maximum of 5%) and a similarly low percentage of broken kernels. Most important of all: it is all non-genetically modified (non-GMO), which is ironic as we are one of the largest traders of non-GMO corn in the world and are based in the same small town as Monsanto, who manufacture GM corn seeds.

The biggest challenge for Russian agriculture is the extremes of temperature – very hot in the summer and very cold in the winter. Agriculture is very weather dependent. The majority of production is winter wheat, which is sown in September-October and harvested in July. Acreage is split 50/50 between winter and spring wheat but the yield and therefore the production is higher for winter wheat. Spring wheat is sown in areas that are too cold for winter wheat. The earth is too hard for farmers to get the seeds into the ground and even if they could plant the stuff it would just die. The winter temperatures go as low as minus 30 or minus 40 degrees Centigrade in Siberia.

Are your deals based on flat price or are you hedged somehow?

Almost all of our transactions are traded flat price. We hedge some of our exposure with derivative contracts: futures or options that are traded on exchanges such as Chicago, Kansas, LIFFE or MATIF, or through ‘Over the Counter’ or “OTC” contracts with brokers in London & Chicago. We also hedge our currency exposure as we buy often in roubles, but sell in US dollars or Euros.

The correlation between Chicago and Black Sea wheat is not actually sufficient to be a good hedge. Some put the correlation at 25 percent. Russian 12.5 percent milling wheat is closer to the wheat quality traded in Kansas City, rather than the soft red wheat that is traded on Chicago. Soft red wheat is an inferior quality, low protein biscuit or even feed wheat – as indeed is MATIF – with only 11 percent protein and few milling specifications.

Nonetheless we tend to hedge on Chicago because it is more liquid than Kansas. We have also been instrumental in getting a new product off the ground, which is called a Black Sea swap, which is a non deliverable derivative based on the price of Russian 12.5% normalised to a parity of FOB Novorossisk. Brokers use the benchmark pricing of PLATTS to price this market and counterparties are approved on the same basis as counterparties in any cash traded business with the broker checking with both buyer and seller that they are approved counterparts. There is some interest to have this product cleared by an exchange and given that Russian milling wheat prices have become such a benchmark for global trade I predict that this will only be a matter of time before it comes to fruition.

However the best hedge for Russian wheat is…. Russian wheat! We prefer to hedge ourselves on the physical markets rather than the futures markets.

How does that work?

We generally only sell forward two to three months, so a lot of the trades we do are relatively spot, meaning that they will be executed within four to six weeks from the date concluded. A lot of our positions are backed up or hedged by our Russian partners or other suppliers. We buy from them on a FOB basis and often convert the sales into CIFFO and take on both the risks and rewards of providing such a service to our clients.

We often hedge our sales of Russian corn, which is a relatively illiquid market, by buying Ukrainian corn. So we might sell Russian corn for shipment in September and buy Ukrainian corn as hedge for delivery in October. Then when we finally cover our sale of Russian corn we sell out the Ukrainian corn that we bought as a hedge. We do this to reduce our risk exposure on movements in the flat price.

We are effectively trading the differentials between different qualities, geographies and different shipments. We try to be relatively cautious in taking large long or short positions on the market and we will always monitor our position limits and the amount of risk that we are taking. We try to keep risks within pre-defined limits – limits that are relatively conservative. This summer we will be implementing a new software system that tracks our positions and can calculate our profit and loss; our value-at-risk (VAR), issue invoices and keep track of our inventories.

This is not the sort of image that most people have of commodity trading, but it is what most traders do – at least physical traders. We are not big speculators. You can easily lose a huge amount of money if you go off and take flat price positions – and then fall in love with them!

How do you think commodity markets are going to change over the next few years?

There is going to be further consolidation – for better or worse. Certain big trading companies want to increase their global footprint and secure their positions as suppliers of food commodities from different origins.

There is a lot of competition in the agri-markets and trading companies are looking at ways to add value to their operations. One way is through owning processing or logistical assets, or even land. ADM for example loses money now on trading but makes it on processing. Glencore Ags recently said that less than fifteen percent of their profits come from trading, while the rest comes from assets. I think that is the future for the bigger players. They need these huge assets.

So traders are moving towards owning assets while maintaining a global trading presence at origin and destination.

Would you recommend young people to go into the commodity business?

One hundred per cent – yes! It is a fascinating industry to be involved in. It is a real business – real grain moving from real farmers to produce real food such as bread and pasta. It is not a bunch of people sitting around a computer screen betting on price moves.

What advice would you give to some one just starting?

Learn and listen and talk to as many people as you can in the business. Try to get some work experience and of course join GAFTA so as to learn about the trade by taking a course such as the Foundation Course or the Distance Learning Programme (DLP).

Thank you Swithun for your time.

The full version of this interview appears in my new book Commodity Conversations, available now on Amazon