Southwest's Charm Not Enough to Lure Investors?

Southwest Airlines Co (LUV) has been a darling for airline stock pickers. But is it anymore? I do not know. Is it overvalued or undervalued? Please see the below link to find it out.

Southwest Airlines Co (LUV)- Valuation Report as of May 5, 2014

The most conservative fundamental value I can derive is $21.52.
The most aggressive fundamental value I can derive is $26.59.

Please email me at nroop.bhavsar1@gmail.com should you have any other questions.

Darden still fights...

Darden Restaurant Inc (DRI) still has potential to outperform market, but I, for me at least, do not know the timing.

Please see the below link to check out my valuation report for Darden. I recommend to HOLD.
Darden Restaurants Inc- Brief Valuation

Vitamins are essential...

Please refer to the following link for my latest valuation of Vitamin Shoppe, Inc.

Vitamin Shoppe, Inc (VSI)- Valuation Report

Boom Burrito Boom...

Another mind-boggling earnings release. One of the top growing restaurant chains lately, Chipotle (CMG: NYSE), likes to beat analysts' estimates. They have been doing that more consistently than their contemporaries because of their ability to control economy of scale and to keep attracting larger and larger customer base. While I am writing this, CMG has been up for 13.76% since yesterday's close.

Many investors really think it is inflated or overpriced. I am not in clear state to defend CMG's current price or price trend, but I would consider that as emotional bias of investors. Except Berkshire Hathway, all companies trading above $300 face the same problem. Why? These price range belongs to a tiny set of companies from a set of thousands of companies currently being traded. Isn't this bias obvious? I think it is. But let's keep behavioral finance aside and focus on fundamentals. Based on my valuation model (based on $439.07 closing price of 10/17/2013), CMG is still undervalued! Below are the few points which may help make my case:

• Consistently decreasing debt/ equity ratio considering the fact that they have been pretty much at the same place in terms of raising capital through equity.
• Skyrocketing growth in revenues and net income (Needless to write!!)
• Impressive ROE year over year
• Robust growth in operating cash flow
• Free cash flow per share and EPS forecasts are way higher beyond the peers 
• Based on all above, company financials, consensus estimates and other relevant market data, I am getting a fundamental stock price range of $612 to $701.

All I believe is that CMG may not be magnificently undervalued, but it is not overvalued for sure considering all numbers and forecasts.

No need to get panic about Darden...

Oh, there is too much competition. Why do we see so called red indicators in company's financials? Activist investor is demanding spinning off company's restaurants to better access share performance. All of these cause some discomfort to investors who like value investing. Restaurants like those from Darden Restaurants Inc (NYSE: DRI) who have been at the corner of our streets for longer time, are not certainly the growth candidates like Buffalo Wild Wings, Chipotle etc. Therefore, if they are growing slowly or there is no growth, it should not raise investors' eyes.

Restaurants industry faces one of the most fierce competition among other industries. It is significantly driven by consumer confidence, overall economy, weather, cost of raw food materials and diversification. Recently, NRN has released that months of September and October or overall Q4 of 2013 will be testing time for the industry because of US Government Shutdown and debt ceiling issues. Clearly, consumers are not ready to spend as much as they used to do when economy was in so called clear shape 2 months ago.

I have gone through DRI's financials, forecasts and ratios. I have created brief valuation model based on its dividends and free cash flow forecasts. And surprisingly, I have not found anything which makes me join the herd who is cautious about investing in DRI. Despite of 7% growth in revenues from 2012, operating margin squeezed by 12%. The most straight forward reasons behind this are increasing inflation in cost of raw goods and in labor rates. And that led to decrease in net income by 12% as well. ROE stands at 6.4% as compared to 8.3% in 2012.

But as I always believe, cash is the king. DRI has been able to generate $949m cash from operating activities in 2013 as compared to $762m in 2012 and $264m free cash flow to equity holders in 2013 as compared to $122m in 2012. Moreover, DRI has consistently increased distributing their earnings as dividends. It provides good source of income as part of total return. According to my model, at the end of trading day 10/11/2013, DRI's fundamental value based on dividend forecast should be $52.04-$54.89 and based on free cash flow to equity forecast should be $51.73-$56.30. In either case, it is above the closing price of 10/11/2013 which is $50.50.

Looking at my limited "working" experience in equity valuation, I may not provide insightful analysis. But since I use sensitivity analysis to derive fundamental price range, I can surely give my opinion for DRI as "Neutral-- Hold it" looking at the numbers.

$80 bil to $5bil... Painful (ouch!)

Source: Yahoo Finance

They pioneered the smartphone market. They made it ubiquitous. They nearly ruled it for a decade. They made people addicted to the phones. They sustained the barriers to entry for competitors for years... And as per ECON 101, barriers were supposed to be broken. Players were supposed to enter... They felt possible long-term threat. But they didn't innovate. They saw their market share shrinking slowly. But they didn't innovate. They saw continuous decline in market share and customer base. They thought about innovation. They considered their R&D lightly. They suffered. They launched something exceptional. And they realized it was too late. They, the pioneer of the booming smartphone market, started considering strategic alternatives yesterday. Who are they? They are Research in Motion, Waterloo, ON, Canada based company, who pioneered BlackBerry, aka Crackberry (This name has nothing to do with their demise, but it was given when BlackBerry was the only smartphone option).

When I was young, I always wanted to own BlackBerry. And that's why I had BlackBerry as my first smartphone in mid 2009. Since then, I have had BlackBerry only. Currently, I am using BlackBerry Z10, runs on BB's new OS, BB10. I neither own any BBRY stock nor sit on their Board. I just want to writ what I feel. These should be enough disclosures for any conflict of interests!

BB 10, is by far the best RIMM has developed. I will not use word "innovate", because it may attract some critics. Apple's iPhones and Google's Android devices have become so "generic" these days, which is the prime factor for BBRY's dwindling customer base. The way BB 10 works, consider fast & smooth, if it was launched 2 years ago, the results could have been different. Only, the only, problem it has, is lack of apps. They have lost developers' interests as well along with customers. Recently, they announced to offer BBM, their premier messaging service, to other platforms. I am not really sure how useful it can be. But one thing I am absolutely sure about is BB 10 is all they can offer. There is nothing beyond that.

I have no vision for their future. They may be out of the business in 2015 when I will be hunting for a new phone. There is a huge possibility that I will not be able to get BBRY phone in the market in 2015. But I strongly believe that I will have good solid time with current Z 10 I have until 2015.

From one corner of my heart, I thank Apple and Google for bringing smartphone market to this level in such a short span. And that is the premier reason why BlackBerry developed their best product. And I could get a chance to use that!

Novo Nordisk Roars Again...

Novo Nordisk A/S, NYSE: NVO, a Denmark based global pharma giant, has been one of my top healthcare picks since long time. Why? Simple reasons:

• Impressive & deep pipeline
• Pipeline primarily focused on Diabetes, a chronic disease which has been delivering global burden to healthcare. According to International Diabetes Federation, approximately 552 million people in world will have diabetes. 
• Sustainable equity and cash flow growth

Source: Yahoo Finance

At the end of Q2 2013, NVO announced better outlook for the rest of 2013 as compared to their announcement of outlook on May 1. Booming sales of Victoza, Modern Insulins and their other long standing diabetes products have given them a great position in this disease sector. And they will continue to do that as per analysts' expectations.

Illegal Insider Trading

Wire tapes... SEC... FBI...Whistle blowing?... Arrest... Plead guilty?... And what not?... Bottom line is Illegal Insider Trading- A tagline which we have been hearing about for past 2-3 years. Why does it happen on the first place? And if that happens, why does it come to public after years? I guess it is a part of a vicious cycle. And this does not mean I favor some/rare insider trading. It must not happen at all to preserve the integrity of financial markets which drive the globe in all ways.

When economy is booming, everyone tries make more money to save their jobs and their company position. No one bothers to investigate why he or she or they are making insane amount of money. But when everything cools down and if that cooling down turns in to a recession or freezing of liquidity, authorities wonder why these have happened. And they start investigation, they find culprits. All get warned. Temporary freeze in insider trading. And again, when economy picks up, competition to make money and to chase big traders/ banks begins ("Chasing Goldman Sachs" book depicts how traders/ hedge funds want to make money so badly that they forget ethics... Why? Just to combat the competition. If trading platform of ABC bank makes this much, why can't we do that?).

This must stop or extra efforts must be provided to prevent it. Whole world runs on financial markets. If it does not save its integrity, everything becomes vulnerable to shatter.

Flying and Soaring Watson Pharmaceuticals

I estimated and you beat it. That is what Watson Pharmaceuticals (NYSE: WPI) has done to me! WPI has always been my favorite healthcare pick alongside Novo Nordisk for a year. Strong fundamentals, eye-catching financials, robust pipeline and stupendous expansion- this is what WPI stands for to me. Today Watson released their 2Q 2012 earnings and they beat all estimates. Whether you give credit to generic Lipitor(r) or to generic Lovenox(r) or any of the above qualities I mentioned, Watson has been delivering.

Watson is one of the biggest and fastest growing generics manufacturing company in the world. As per above figure, its global brands business complements its rapidly expanding global generics and anda distribution businesses. 2Q 2012 results do not reflect the effects of recently passed Healthcare Reform Bill which provides rosy outlook for generics. Moreover, it does not reflect the recent acquisition of Actavis. If WPI gains the expected synergy from Actavis acquisition during 4Q 2012, it will prepare WPI to set 2012 annual revenues to beat the street estimates.

When I ran the valuation model few months ago, I got the price target of approximately $73. And WPI is above that right now. It was and it is a "strong buy" to me.

Business Cycle Transparency

Developed economies are more transparent than emerging economies are. We all have heard about this, haven't we? If that is the fact, then I need to make myself work harder to believe it.

After the great recession hit the world in the year 2008, I could never understand clearly in what phase of the business cycle the US was and has been. Is it early upswing or late upswing or is it slowdown? Only thing I am sure about is that it is certainly neither initial recovery nor recession (please correct me if I am wrong). Recent healthy economic growth and relatively low inflation in the US suggests that we are in early upswing. There are no restrictive policies in the place as of now and that does not put us in the late upswing phase. But nervous investors have begun to think that equities are volatile and stock market is near its all-time peak in the 2007. Isn't that favoring late upswing? It is dilemma to me since I am not an economist! Capital market expectations are always critical to judge after prolonged recessions and a depression. If we observe emerging economies, they are believed to bounce back from shocks faster than developed nations do. This was true even after the great recession. For example, India is clearly in late upswing phase where it is feeling tremendous inflationary pressure. Equity markets in India have shown considerable volatility. Monetary policies have become restrictive and short rates are rising to curb boom mentality. India is showing business cycle transparency which I want to observe here in the US. But I may be asking too much from $14 trillion economy. Perhaps that transparency has partly been offset by the great recession.

As I heard and expected, Apple has delivered finally...

$40, $50, $60, $70, $80, $90, $100 billion and counting. This is how the world's most valuable company has increased its cash over the last 3 years. Whenever companies sit on huge cash piles, there are always 2 possibilities. First, companies become conservative, especially post-recession years, in capital investments and hiring, and reports plethora of cash to combat another economic stress. Second, companies face controversial times from the investors. We strongly believe that Apple falls in to second choice.

When do companies pay dividends and when do they repurchase shares? Simple answers and simple signals. When a company believes that there are no more opportunities to invest money, acquire assets or there is a shrinking room for current above average growth, they pay dividends to reward investors. And when a company believes that their equity is undervalued, they repurchase some shares in the market. I have not performed any equity fundamentals on $AAPL and this is why I cannot say if its equity market value is undervalued or overvalued. But I can somehow convince myself that there is some decrease in growth is forecast by the management after a dream post-recession run and paying dividends is the best way to keep investors tagged along.

As I heard and expected over the last few months, Apple has finally announced to pay dividends and $10 billion worth of share repurchase today. Though its dividend yield is less than its peers, it is going to be interesting new chapter for Apple, being considered mature in the market.

Circuit City, you are not alone- said Best Buy

It was Forbes magazine's "Company of the Year 2004" and then it made in to the Fortune's List of Most Admired Companies in 2006. It survived the financial catastrophe after 2007 unlike its rival Circuit City, but seemingly it does not want to leave its pal- Circuit City alone.

Consumer spending has been above the levels businesses saw in 2008-2009. As per reliable sources, Black Friday and Cyber Monday sales of the year 2011 were up by 26% as compared to the year 2010. These all favor the prosperity of the retailers like Best Buy. But that is not the fact. Financial statements and stock performance of Best Buy deliver the different and dubious story.

Source: Yahoo! Finance

Best Buy is losing their support in the equity markets."Going out of the business" is a probability after 2-3 years and no one is able to put that out of the question. But why only Best Buy? My only explicable answer is:  "the fierce competition" from diversified retailers who have many other things to offer unlike Best Buy. Free shipping, heavy discounts and extended season of the deals cause only one thing and that is shrinking Best Buy's margins. I have no specific thing in my mind which Best Buy can do to come out of this misery, but if they are not able to do anything revolutionary, those shrinking margins will eventually burn all cash.

Few days ago, I read an article on Amazon, which was considered to be "Online store of Best Buy". I could not deny with that, could you? Because that sums up everything here...

Cash is "The King"

What is the difference between the great recession started in 2007-2008 and the global crisis we are currently facing? It is a 4 letter simple word. CASH- no matter what currency it is.

If I focus on the US, the biggest economy in the world, all big banks and corporations are sitting on the huge piles of cash. This was not the case 4 years ago. Most of them were cash stricken. After Apple Inc, the most valued company on this planet, released its 2011 Q2 results, it showed over $70 billions of cash & cash equivalents which is more than the GDP of many countries. Lessons learned perfectly- that's what we can say! Now the question is if these mammoth companies have enormous amount of cash, then why are we on the verge of another worldwide crisis? It is because everyone is too skeptical about economy, political unrest and discomfort in European economies. No one wants to spend their cash based on weak outlooks. If there is no cash circulating in the markets, then how can one make money and drive economy along?

In the course of company's life cycle, if management thinks there is no more growth ahead, then they distribute  excess cash as dividends to reward investors or buy back their own shares. Recently, share buy back has been a spree which is a good sign since companies buy back their "cheap" shares in anticipation of increase in share value. But many companies are issuing cheaper bonds to raise cash and use that cash to buy back their shares. Isn't it unusual? Why would they not use abundant cash they have and end up paying interest payments to bond holders? We have connected the dots here. No one wants to use "cash" they have. Everyone has figured out that cash is the only way to get their company out of the potential financial mess. And once again, it has been proved that cash is the only king you want to save till the end.

Netflix confuses subscribers with a canny idea...

Price hikes. They are riding on the ECON 101 rule of growth and competitiveness in an industry. From my perspective, I was ok with paying half dozen bucks more a month after I heard the news couple of months ago. I think the money I pay for the service and access to the huge library I get is worth. But I am not on the same page with many of the 23 million domestic subscribers. We all do not need to be...

Reed Hastings, CEO of Netflix, sent an apology email to all domestic subscribers for the current pricing disappointment the company has given to their subscribers. The email also contains a brief on the company's plan to separate their streaming (Netflix) and DVD rental unit (will be named as Qwikster). Why? Why would they do such thing when everyone is still coping with the mess company has recently created? And I can imagine a canny idea behind this.

Internet access is ubiquitous. YouTube, Amazon Instant Streaming, Dish Network's acquisition of Blockbuster library and many more to come to share a pie of video streaming business. Growth is going to be good for next few years. Decline phase is not in sight. While the reverse is the destiny for DVD business which has sluggish growth forecasts and is going to be nearly unseen in next 10-15 years. In simple language, if weak outlook for DVD business persists, then Netflix (streaming only) is a better place to get handsome ROI than Netflix (Current: streaming + DVD).

"Wall Street to Netflix: Try Again". I read that on Twitter. After Hastings's public apology, share price tumbled further. So, a tweet justifies a stock market reaction to this event. But now I do not think alike. This seems like a smart move to me rather than pleasing the investors on day-to-day basis. Growth is not immortal. The more you extend your maturity phase, the longer you survive. And Netflix may have learned that already.

What Is Risk-Free Rate?

Let's begin with RISK-FREE RATE 101 class. (Prerequisites: Default-free, Treasury, Safe, Secured)

2 years in the business school and reading all those books of CFA program curriculum. The most repeated term has been- Risk-Free Rate (Rf). It is considered as yield of US Treasury securities. US Government is (was?) considered as default-free thought it fought hard to prevent default recently. Whenever global economy melts or shakes, investors look for Treasury securities. They have been known as the safest investment since there is no volatility or risk included. We employ many risk-return tools (for example, Sharpe Ratio) to calculate excess return achieved by investing in particular assets. This excess return is calculated by considering risk-free rate as benchmark. Many countries with political instability and higher inflation rates do not have their risk-free rates. They add their inflation rate to US risk-free rate to get the benchmark rate for their country. And thus long-term bond yields and so on. This is what the biggest economy stands for.

But in the recent turmoil, I am not able to believe completely that we should still use Treasury yields as risk-free rate or not? I do not want to discuss why S&P has recently downgraded US credit ratings to AA+ from AAA. It may be reversed or may be not. S&P might be wrong in deriving this verdict or they might be late in doing this. I do not know the facts. But few things I surely know that there are few problems in Washington DC. There are serious fiscal challenges we have been facing. Looking at the current scenarios, US may not deserve AAA. But when country has to put efforts to prevent default which US did last week, their risk-free rate should not be considered as default-free rate or benchmark rate. Why can't we change that? Why can't we use risk-free rates from countries like UK, Germany and Canada who still have AAA?

I am not sure about literature we used in the business school, but CFA institute updates its books every year based on recent market conditions. I will not be surprised if I see Canadian rates as risk-free rate in those books next year...

Chipotle: Expectations vs Fundamentals...

I never thought that "burritos" would bring me out from hibernation (it has been nearly more than 3 weeks since I wrote the last blog). I love their food. Many of us do. It is Chipotle Mexican Grill, Inc (ticker: CMG). Short, simple and affordable- 3 words help it rule its peers. An inspirational success and growth story. Following chart  says it all:

Phenomenal growth. Handsome return to investors. Stock was worth $38 on November 20, 2008. Stock is worth $330 today. Do I need to show return figures? Company's business model is fundamentally strong. They target fast food consumers who want to spend $5-$10 on their meals. It has nicely managed the global food inflation. Its store operate in all metropolitan area of the US and try to provide affordable options in such areas. Conclusion: Sweet & Sound!

Yesterday, they announced their second quarter earnings. Earnings were pretty good despite of rough outlook of the global economy. All numbers were decent and higher than last quarter. But I heard the voice.... "Clear Disappointment". I am still trying to figure out why I was supposed to hear that. Reason was--- they missed analysts' estimates. What bothers me is they missed it by dozen cents. Negative earnings surprise. I understand that analysts on the street perform all fundamental analysis and provide their estimates. But I still consider a phrase "Failing to meet expectations" which may make another phrase "Clear Disappointment". If we compare all the numbers with its peers and industry overall, they are still the leader. There is nothing wrong happening with its revenue generating model. It is partially because of too much expectations, isn't it?

Based on Chipotle's news, I wonder what happens in the market if mammoth Apple Inc misses its estimates. Worse. Worst. Why? They never respect analysts' estimates and always believe it positive earnings surprise!! Yesterday, they announced those bottom line numbers 25% greater than estimates. And that sends the story to investors for their EXPECTATIONS from Apple in the next quarter...

How long can you put on your 3D glasses?

When I graduated from high school, I and one of my friends went for IMAX 3D "show". I did not write "movie" because it was a 30 minutes educational/ informative documentary which we always find here in museums. It was expensive. And rare! Times have changed. Now every Friday, we get at least one movie in 3D to spend our wealth on.

Before 3-4 years, when releasing movies in 3D was not as normal as it is now, it started to change the definition of movie watching on the big screens. Stumbling Regal Entertainment Group & AMC Theatres during the painful recession got some room to breathe. Rapid rise of 3D movies boost the earnings for Regal Group, RealD and the hopes for an IPO for AMC. Entertainment sector was almost back on the track with the 3D hits like Toy Story 3, Avatar, Transformers and Harry Potter. Then AMC postponed their IPO plans. Why?

• 3D Burnout- Excess leads to an destruction. Well said! Burnout is the term often used during mortgage refinancing phase for prepayments. When rates are low, you refinance the loan by prepayments. After few years, when rates become lower again, you have nothing much left to refinance. Same applies here. 3D movies and its craze cannot be placed in the category of sustainable items.
• Online movie providers- Ah! Internet is killing everyone. Surge in the paid subscription based online movie providers like Netflix, Amazon, YouTube have clearly staged their competition with these entertainment giants.
• 3D TVs- Dance until music stops. And that is the reason why we can see the brand new isle of 3D TVs at Best Buy or Wal-Mart stores. 

RealD does many innovative things. It recently launches "Wimbledon 3D" for 2011 Grand Slam. Beautiful. Wimbledon 2011 is still in progress, but still RealD stock is suffering today. Why? It is because of less than expected, not poor, box-office performance of Cars 2 which also released in 3D during last weekend. It is a lovely example of positive correlation, isn't it?

Let's see how long we are able to witness the entertainment industry's fight against sustainability and volatility.

A documentary explains "The Capture Hypothesis"

We have avoided disaster and we are recovering... But the men and institutions that caused the crisis are still in power... and that needs to change. They (mammoth banks) will tell us that we need them, and that what they do is too complicated for us to understand. They will tell us it wont happen again... It wont be easy, but some things are worth fighting for.

Finally, I got some time to watch last year's academy award winning documentary, "Inside Job". And what a masterpiece it was! Perhaps, it is the finest documentary I have seen in my life. Neat and straight. It is based on the catastrophic financial crisis from which we are still trying to recover. Last year, I read a book by Suzanne McGee, "Chasing Goldman Sachs: How the masters of the universe melted Wall Street down... and why they will take us to the brink again." The reasons why I like this book and this documentary are the timing, my education and my area of interest. I was about to graduate from business school in  the midst of this crisis. And I was exposed directly or indirectly to majority of the events listed in the book and shown in the documentary.

"Inside Job" emphasizes on the critical issues like political influence, lobbying power of Wall St, corruption- collectively "Wall Street Government" and other market changing events like introduction of derivatives in early 90's, housing bubble, ponzi schemes, subprime lending and the rise of structured products like MBS, CDO and credit derivatives like CDS. But the most important thing I have understood through this documentary is an industry regulation theory, "Capture Hypothesis". According to this theory, regulators of different industries are elected/selected from the pool of experienced and influencing candidates from their respective industries only. For example, regulator for environmental issues cannot be selected from the finance & banking industry. And that is the reason why regulators are more biased towards industry rather than consumers. If they do not support the industry, their spot will become endangered. That is what happened with the failure of 3 big Iceland banks. That is what happened with the regulators' decisions(influenced by Henry Paulson and other top executives from number of big banks) of permitting banks' leverage ratio to rise as much as 20:1 and loosening the regulations on derivatives. Eventually, this led to the collapse of Lehman Brothers, AIG, Bear Sterns, Merrill Lynch, Washington Mutual, Wachovia and many others.

When I was in grad school, I had to watch Wall Street, Boiler Room and Rogue Trader. I am sure that B-school finance majors will have to watch documentaries like "Inside Job" down the roads since ethics and finance and banking and investment are all coherent with one another.

"New Normal"... Hope or Frustration?

Like every morning, I settled at my desk, logged in to my computer (Bloomberg Terminal) and read news. And saw a news story elaborating few economists' warning on unemployment rate in the US. Since the downturn started, we have been listening to and looking at all fiscal efforts to combat higher unemployment rate which is the key impediment to achieve economic growth. We have managed to drop it down to 9% and started to believe that within 3-4 years, it may be at its normal level. What is this "Normal Level"? Is it decided by the congress or economists or something else? Unexpected and turtle speed recovery in developed economies has certainly shifted those economic graphs.

Current unemployment rate is seen as "New Normal" by few economists. If that turns out to be true, then 8-9% rate will stay in normal business cycle. It may climb to 13% or 15% or 18%, if another downturn arrives. But no more hopes for those 5% or 7%?

Similar things follow in the case of US Debt Ceiling and US Credit Ratings. If we consider "New Normal" in debt ceiling, then new ceiling will allow the Government to borrow more than they are doing now. More public debt. Higher debt to GDP ratio. We know the consequences. I still remember one of the story on US credit ratings published couple of years ago. It said "If US credit rating is downgraded to AA from AAA, then new AAA will be AA." Doesn't it sound like "New Normal"? Yes, it does. New Normal changes the benchmarks.


Establishing "New Normal" for unemployment rate, debt ceiling and credit rating (... and many more may come) have positive consequences as well. Based on hopes and optimism, they give us room to accelerate recovery and to acquire potential growth opportunities. But that is what we have been doing since last three years. We might have started to realize that perhaps there is no hope. Potential frustration may make us prompt to start everything from scratch... and that can be done by creating new zeros... new benchmarks... new normal.

Inflation, Commodity Futures, Speculating, Hedging... And Coffee.

Few days ago, I read the news uttering about the Americans' reactions on the inflation- especially on higher food prices. And I immediately tweeted that the Americans should not outcry for higher prices when they have no idea about the painful inflation in the emerging markets. I spent 22 years in India and I can understand how cheaper the daily necessities in the US are.

Commodity futures are positively correlated with the inflation and that is the reason why investors choose them as an inflation-hedge in the long-run. Commodity prices are speculator's & hedger's game besides the global demand-supply. If perceived price risk in the future is higher for consumers of commodities, they buy the futures and the net long position sends market towards the contango. And if perceived price risk in the future is higher for producers of commodities, they sell the futures and the net short position pushes market towards the backwardation. Generally, perceived price risk in the future is higher for producers and because of this, commodity markets are in normal backwardation most of the time. But consistent upward pressure in the global inflation in the recent years has pushed the global commodity market in normal contango.

If we talk about the whopping prices of coffee, Starbucks is being considered as one of the culprits who pushed coffee futures in the contagion world. Based on their recent quarterly reports, they have shown noticeable hedging activities especially in coffee futures. Their speculation of higher coffee prices in the future made them take net long positions in the coffee futures. Per recent Financial Times news story, they are fully hedged against their needs until the end of this calendar year in April. And that tells the whole story about the speculation. I do not find any fundamentals.


It is a simple phenomenon. If bigger players like Starbucks keep on buying futures, then demand for futures increases regardless of other fundamental or economic factors. And contango stands out as a bull market with a possible commodity bubble. It is not illegal for corporations to perform hedging activities, but there should be some difference between speculating and hedging. Per my knowledge, whatever Starbucks is doing is speculation and whatever all airlines are doing is hedging.