Cheaper coffee helps Egberts take on Kraft

LONDON/AMSTERDAM Tue Jun 26, 2012 6:51am EDT

Steam rises from a mug bearing the Cadbury logo in this photo illustration taken in Pitlochry, Scotland February 2, 2010. REUTERS/Russell Cheyne

Steam rises from a mug bearing the Cadbury logo in this photo illustration taken in Pitlochry, Scotland February 2, 2010.

Credit: Reuters/Russell Cheyne

LONDON/AMSTERDAM (Reuters) - Cheaper arabica beans and ambitious goals have given Dutch group D.E. Master Blenders 1753 DEMB.AS, maker of Douwe Egberts, a lift as it tries to overtake rival Kraft KFT.N to become the second largest player in the coffee world.

It has the freedom and war chest to take on Kraft and emulate world No 1 Nestle (NESN.VX) as it invests in its one-cup Senseo system, looks to expand outside Western Europe and perk up instant coffee output.

The hidden giant of the global $58 billion coffee market is flexing its muscles after being buried as part of the U.S. conglomerate Sara Lee SLE.N for 34 years. It is being spun off and the new group, to be based in Amsterdam, is eyeing deals with 1 billion euros ($1.3 billion) to spend.

Meanwhile Kraft, which has a wide range of products including Maxwell House coffee but also Cadbury chocolate and Oreo cookies, is busy demerging and analysts say its focus may be elsewhere.

Analysts say Douwe Egberts, with its almost-exclusive focus on making coffee, could gain from the trend to more expensive blends while top-quality arabica coffee languishes at its lowest price for two years after a bumper crop in Brazil.

"We think that the recent fall in coffee costs and the potential for the shares to become part of a European index will support the share price, while after the breakup of Kraft it remains unclear the strategic direction of the Kraft coffee business," said analyst Pablo Zuanic at brokers Liberum Capital.

The 5 billion euro group being spun out of Sara Lee started unofficial grey market trading on June 12 ahead of its official trading start on July 9, and the shares last traded at 8.28 euros on Tuesday compared to its 8 euro start.

Chief Executive Michiel Herkemij says his group will focus on Brazil, eastern Europe and Asia and says his ambition is to become number two in the coffee world ahead of Kraft.

"We want to achieve that in several ways, by investing in new packaging design, improving quality and machines. We want to have new flavors," he said.

Chief Financial Officer Michel Cup says the group will have about one billion euros to invest in acquisitions and adds, "We will be looking at Russia, Poland, Thailand and Indonesia".

Nestle leads the global coffee market with a share of 22.8 percent, followed by Kraft on 12.9 percent and Douwe Egberts on 5.9 percent. The Dutch group is second to Kraft in ground coffee, but small in instant coffee where Nestle dominates.

Nearly three-quarters of the group's 2.6 billion euro annual sales comes from five markets - the Netherlands, Brazil, France, Belgium and Germany - and it hopes success in Brazil can be replicated in other emerging markets like east Europe and Asia.

NESPRESSO COMPETITION

The company was started by Egberts Douwe as a grocery shop in 1753 and Dutch Prime Minister Mark Rutte has welcomed the return of the headquarters to the Netherlands.

But many Dutch coffee drinkers have a Nestle top-of-the-range Nespresso machine at home and not a Senseo, a sign that Douwe Egberts has work to do to improve its brand.

"I am very proud that Douwe Egberts is Dutch. But I don't think they will be able to compete with Nespresso. Nespresso has much better quality, the coffee is very strong and tasty," said Amsterdam coffee drinker Geert Lohgman.

Senseo, launched in 2001, competes with Nestle's Nespresso and Dolce Gusto as well as Kraft's Tassimo, while Douwe Egberts' L'Or espresso capsules can be used in Nespresso machines, although here it is facing legal challenges from Nestle.

Senseo and L'Or products which make up 19 percent of the group's turnover, while roast and ground coffee account for nearly half its annual sales.

"Senseo remains the most affordable single serve coffee platform in Western Europe, but the business had mixed results until recently. We expect Senseo to regain share from comparable offerings as well as taking share from Tassimo coffee discs," said Liberum's Zuanic.

The new management team is upbeat about its prospects and expects annual sales to grow 5-7 percent a year led by the single serve coffee category which is enjoying annual growth of around 30 percent across the industry.

TOO EXPENSIVE

Some fund managers also say that although the company is well-run, the shares may be a bit expensive, creating a risk that Sara Lee shareholders in the United States will sell.

With over 99 percent of Sara Lee shareholders based in the U.S. where the new coffee company does not operate there is expected to be a big swing in the shareholder base towards European funds.

"I believe in its business model, I believe they will do well but it is not yet visible. Currently, you have to pay a premium while there is uncertainty. I'd like to have a discount to buy the shares," SNS Asset Management's Corne van Zeijl said.

Sara Lee shareholders will receive one DE Masters Blenders 1753 share and a special dividend of $3 for each Sara Lee share they own. Then, Sara Lee will change its name to Hillshire Brands Co to reflect its focus as a North American meat company and its shares officially start trading on June 28.

Despite likely selling pressure, analysts point out the low price of coffee and the stock's likely inclusion in relevant stock indices will give the shares early support.

Arabica coffee has been one of the worst performing commodities so far in 2012 due to slack demand and a bumper Brazilian crop, and September arabica coffee futures hover near a two-year low of $1.5010 per pound, the lowest level for the benchmark coffee since June 2010.

"There's nothing in the short term providing a base for prices," said Sudakshina Unnikrishnan, commodities analyst at Barclays Capital.

Other analysts say the shares could get a boost by inclusion in the Amsterdam blue chip index .AEX joining the likes of Heineken, Philips, and Akzo Nobel, and the STOXX EUROPE 600 Food and Beverage index .SX3P alongside Nestle and Unilever.

(Additional reporting by Gilbert Kreijger; and Sarah McFarlane; editing by Anna Willard)

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