News that upmarket chocolatier Hotel Chocolat was planning to float on London’s Alternative Investment Market (Aim) has caught the attention of investors and industry analysts alike. That’s because, short of access to the derivatives market, domestic options to invest in the confectionery industry had all but evaporated after Thorntons, the 100-year-old Derbyshire confectioner, was effectively put out of its misery by Ferrero International, the Piedmontese sweet manufacturer.
Shareholders in Thorntons had suffered years of underperformance and profit warnings, culminating in a drastic cutback in orders from two 0f its biggest retail customers – Tesco and Morrisons – at the outset of 2015. Ferrero subsequently came in with an offer pitched at a 43 per cent premium to Thorntons’ then valuation and the rest is history.
The logical conclusion of Elizabeth David
The Thorntons takeover was perhaps symptomatic of the supermarket price wars that were raging at the time, but you could also argue that it was an indirect consequence of increased sophistication on the part of UK consumers. This discernment is already reflected in another area of the food and beverage market with the rise of Fevertree Drinks (FEVR); a company that has tapped into burgeoning demand for high-end spirits through the provision of mixers of commensurate quality. And just consider whether a retail outlet such as Waitrose, at least in its present form, would have been considered a viable retail proposition as recently as 30 years ago. You could even make the case that the confectionery industry has been something of a laggard given the transformations that have taken place in other areas of the foodstuffs market.
Thorntons’ chocolate, which was once synonymous with luxury consumption, gradually lost its lustre as European brands such as Lindt, which contain a much higher percentage of cocoa solids, gained market share. The deal actually allowed Ferrero to move ahead of its Swiss rival
Chocoladefabriken Lindt & Spruengli AG (SWX:LISN) to become the world's fourth-largest chocolate brand by volume - behind Mondelez International (Nasdaq:MDLZ), Mars Inc and Nestlé SA (NESN:VX).
Developing markets and vertical integration
None of the multinationals mentioned is UK-traded, so the imminent debut of Hotel Chocolat is generating plenty of static in investor chat rooms; a sign, perhaps, that UK investors have developed a sweet tooth for the broader confectionery sector regardless of Thorntons’ well-publicised travails. And why not? The chocolate market is anti-cyclical, or at least it has evolved to that point. Cyclicality has decreased over time as confectionery companies have increased their exposure to emerging market economies, while driving scale benefits through consolidating and centralising their purchasing operations. Confectionery industry growth is mostly in developing markets, and every multinational confectionery company is pursuing that avenue.
So, from an investment angle, you could insulate your portfolio against cyclical downturns by adding exposure to large confectioners in much the same way you might with tobacco, liquor or gambling stocks. But the Hotel Chocolat admission shows that there are specialist thematic plays on offer. The business model certainly seems more focused on prevailing trends than that of Thorntons, particularly in view of the changing UK palate.
The company also offers a vertically integrated trading operation through its chocolate-making factory in Huntingdon, which operates in tandem with retail outlets, cafés and the spa and plantation in St Lucia. Presumably this affords a degree of flexibility in terms of input costs.
And the numbers appear to be moving in the right direction; at its June year-end, Hotel Chocolat booked revenues of £81.1m, a 10.2 per cent increase year on year, and generated cash profits of £7.9m. The clamour ahead of the float certainly augers well for Hotel Chocolat founders Angus Thirlwell and Peter Harris, who stand to make around £20m apiece from cashing in a third of their equity stakes.
IC VIEW:
The investment angle for chocolate forms part of a wider long-term investment theme linked to agricultural produce that has been propagated by international investors, most notably Jim Rogers, co-founder of the Quantum Fund. It also feeds into the narrative governing long-term growth of median incomes in the world’s developing economies. Unless you feel you’re savvy enough to employ derivatives to exploit periodic supply-side disruptions, such as the current El Niño-linked shortfalls, you could do worse than look at a group such as Barry Callebaut AG (Xetra:BCLN), which by any measure, is embedded in the industry. A point also worth considering is the likely effect on demand for cocoa beans once the consumer preference for chocolate with a high degree of cocoa solids gains traction in emerging economies – cocoa beans can only be grown in a relatively narrow range of latitude, so prices are likely to continue outperforming most other cash crops over time.
Favourites: A vertically integrated Hotel Chocolat could provide a compelling model for the industry, although it will be instructive to note the level of institutional support over the long haul. But if you’re convinced about the viability of the chocolate market, you could plump for a producer/value-added proposition such as Barry Callebaut AG (Xetra:BCLN). Essentially a B2B play, Barry Callebaut is one of the world’s largest cocoa producers and grinders. The group was created in 1996 through the merger of the Belgian chocolate producer Callebaut and French company Cacao Barry. Its customer base includes multinational and national branded consumer goods manufacturers and artisanal users of chocolate. In addition, the group provides a comprehensive range of services to the industry in the fields of product development, processing, training and marketing. The group’s shares have been trading in a relatively narrow band and are now in line with their historic discount to peers, but we see this as a long-term thematic play.
Outsiders: It is possible to gain exposure to underlying cocoa prices through an exchange-traded commodity such as ETFS Cocoa (COCO). The underlying contract is predicated on the movement in the price of the cocoa futures contracts used in the Bloomberg Commodity Index, although we always stress that ETC prices can be highly volatile compared with investments such as shares, gilts and bonds. There are also specific issues to take on board, such as counterparty risk and the daily re-set of instruments. So they’re only really suitable for investors with the requisite experience of derivative markets.
