Brazil Wakes up to Premium Blends

October 218 Brazil Wakes up to Premium Blends The Brazilian Specialty-Coffee Market RaboResearch Food & Agribusiness far.rabobank.com Guilherme K. K. Morya Analyst Beverages +55 11 553 726 Summary Brazil is one of the main coffee-consuming countries in the world. In recent years, premium coffee has emerged as a critical driver of consumption growth. Now, there s a BRL 3bn opportunity in Brazilian specialty coffee. Consumer trends are changing. Younger Brazilian consumers are looking for innovation, new experiences, and product traceability. This mindset change has impacted the specialty-coffee market, bringing investments to the sector, as well as new formats (like packaging or online sales platforms) to commercialise these products. In terms of volume, coffee beans are the main format in the specialty-coffee market. However, coffee pods have the highest added value among all formats. Despite the high production costs, there is a promising future for premium coffee in Brazil. Brazil has long been the leader when it comes to global coffee production and exports. According to Rabobank, production should reach record levels at 56.8m bags for the 218/19 crop. In 217, exports reached 3.7m bags. The country is also one of the largest coffee consumers in the world. It currently occupies the second position in terms of consumption (surpassed only by the US) and has demonstrated solid growth (see Figure 1). According to data released by the Brazilian Coffee Industry Association (ABIC), coffee consumption increased by 3.8 percent in 217, reaching 22m bags. Figure 1: Coffee consumption of main global players, 213-217 million 6kg bags 3 25 2 15 1 5 23.4 23.8 24.4 25.2 25.9 2.1 2.3 2.5 21.2 22. 9.4 9.5 9.3 9.7 9.8 213 214 215 216 217 Source: ABIC, ICO, USDA, Rabobank 218 Italy Japan Germany Brazil US Until recently, few Brazilian consumers were regular drinkers of premium coffee. Limited options and high prices kept many from buying products outside of the mainstream brands. In recent years, however, coffee consumption in Brazil has undergone an important change, with customers increasingly demanding better quality and new consumption formats (like coffee pods or cold brew). This growing demand for specialty coffees is already impacting producers, who need to improve production practices. Similarly, coffee companies need to develop new products and blends, focusing on certifications for quality and social sustainability. 1/8 RaboResearch Brazil Wakes up to Premium Blends October 218

The Brazilian coffee market has been showing interesting growth. From 213 to 217, the market grew at an average rate of 2.3 percent, but in 217, it grew at 3.8 percent. Meanwhile, global consumption grew by around 2 percent from 213 to 217 (see Figure 2). Figure 2: Coffee consumption, 213-217 3 1.% 24 8.% million 6kg bags 18 12 6 3.4% 3.8% 2.1% 1.5% 2.5% 2.1% 1.% 1.% 213 214 215 216 217 6.% 4.% 2.%.% annual grotwth rate Source: ABIC, Rabobank 218 Brazil (Coffee Volume) Brazil (Growth Rate) World (Growth Rate) In Brazil, specialty coffee is defined as coffee with a score higher than 8 points on the scale of the Specialty Coffee Association (SCA), that is made of 1 percent arabica beans, and is of certified origin and sustainability. Brazilian specialty coffee showed surprising growth of almost 21 percent in volume from 212 to 216 and appears to have a very promising future, though it still represents just 2.8 percent of the total coffee volume. In a recent survey conducted by Euromonitor, the volume of specialty coffee consumed by Brazilian consumers in 216 was 49, bags, and it is projected to reach 1.1m bags in 221 (see Figure 3). Figure 3: Brazilian premium coffee market by volume, 212-221f 1,2 1, 25% 1,63 3% 25% million 6 kg bags 8 6 4 231 19% 49 13% 2% 15% 1% annual growth rate 2 5% 212 213 214 215 216 217e 218e 219f 22f 221f Premium Coffee Growth Rate (%) % Source: Euromonitor, Rabobank 217 In terms of value, this segment reached BRL 1.7bn (in 216), which represents around 1 percent of the total coffee market in Brazil. Despite a gradual deceleration in the annual growth rate over the coming years, the expansion of specialty coffee is expected to remain robust, with double digits until 221 (see Figure 4). 2/8 RaboResearch Brazil Wakes up to Premium Blends October 218

Figure 4: Brazilian premium coffee market by value, 212-221f* 5, 4,721 35% 29% 4, 28% million BRL 3, 2, 1, 753 2% 1,722 21% 21% 14% 7% annual growth rate 212 213 214 215 216 217f 218f 219f 22f 221f % Value (LHS) Growth rate (RHS) Source: Euromonitor, Rabobank 218 * Note : projected values after 216 Composition of the specialty-coffee market The specialty-coffee market is divided into three categories: beans, capsules, and roasted & ground (R&G). Coffee in bean form represents the largest volume category in specialty coffees (see Figure 5). Beans are mainly consumed in coffee shops, and this channel is expected to increase its relevance in the coming years. In recent years, consumption has started to change, as consumers are trying to replicate the coffee-shop experience at home. This trend has helped to increase sales of at-home consumption of beans, as well as the accessories needed for making coffee. Figure 5: Brazilian premium coffee market per category, 217 R&G 35% R&G is the second-largest category in volume terms. Products are commonly found in retail, and fall somewhere between beans and capsules they are not as practical as capsules and have limited options for preparation compared to beans. Pods 15% Source: Euromonitor, Rabobank 218 Bean 5% Coffee pods are the main format for retail sales and have been showing solid growth, as they are convenient. Although pods represent a low volume of the total amount of coffee consumed, they have significant added value, at an average retail price of around BRL 36/kg (equivalent to USD 8/kg). The market dynamics of coffee pods The capsule market has become very popular in Brazil, as previously discussed in the RaboResearch article Coffee Pods Still Exciting Brazil s Coffee Industry. Demand has been rising rapidly and is expected to continue growing in the coming years. This has encouraged investments by some important players, including Jacobs Douwe Egberts (JDE), Nestlé, and Grupo 3corações. 3/8 RaboResearch Brazil Wakes up to Premium Blends October 218

Since 213, JDE has been selling coffee pods in Brazil under the L Or brand. In 215, the company released Café Pilão coffee pods under the Pilão brand, which is very popular among Brazilians. Both brands are compatible with Nespresso machines. In 216, Nestlé invested BRL 22m to build a Nescafé Dolce Gusto plant in Montes Claros, Brazil. Earlier this year, the company announced an additional investment of BRL 2m in the same plant to double its production capacity, which will produce around 8m pods per year. As a result of good sales performance and increasing demand for coffee pods, 3corações is working on a new production line at its plant in Montes Claros, which costs BRL 2m and should double the group s capsule production to 2m capsules per month. Growth in the capsule market in Brazil has steeply increased, by 41 percent in volume from 212 to 217. From 217 to 222, the average growth rate is expected to reach 8 percent. This represents an increase from the 1, tonnes in 217 to 15, tonnes in 222 (see Figure 6). Figure 6: Brazilian coffee-pod consumption, 212-222f thousand tonnes 16 12 8 4 3 6 7 9 1 11 12 13 14 15 2-212 213 214 215 216 217 218f 219f 22f 221f 222f Actual Forecast Source: Euromonitor, Rabobank 218 Coffee pods were first sold in Brazil in 26, imported by Nestlé from Switzerland. In 213, the end of the Nespresso patent created an opportunity to produce compatible machine models for pods. Generic machines at lower prices have undoubtedly helped make the system more popular, attracting new consumers. Investments are not only being made by large players, but also by smaller companies, motivated by the expected consumption growth in the short and medium term. Nevertheless, companies are also expecting Brazil to become an exporter of coffee capsules to the rest of Latin America in the medium term. Who are these new customers? Over the last few years, consumer behaviour has been changing. Younger customers have different values, habits, and preferences. They are looking for products that are: practical fresh healthy organic easily accessible (omnichannel) premium (in terms of quality and sustainability) transparent (when it comes to traceability and integrity) 4/8 RaboResearch Brazil Wakes up to Premium Blends October 218

As a result of these changing preferences, Brazilian consumers are slowly moving towards more specialty-coffee consumption. Younger consumers (most of them millennials) are already the majority in Brazil, and they tend to be more open to new experiences, innovations (such as cold brew and iced coffee), and new types of preparation (including replicating the coffee shop experience at home) (see Figure 7). Figure 7: Brazilian demographics by age, 218 4 Population (million) 2 12m younger consumers (Millenials + Generation Z) 4m Generation X 24m baby boomers - 1 1-14 15-19 2-24 25-29 3-34 35-39 Age 4-44 45-49 5-54 55-59 6-64 7-74 74 or older Source: IBGE, Rabobank 218 What are the main channels? Consumption of specialty coffees takes place through both horeca (out of home) and retail (at home). The split in consumption of specialty coffees is very similar to the rest of the Brazilian coffee market, as the majority takes place at home. Out-of-home consumption had been slowly gaining share, starting in the early 2s, but has recently started to stagnate due to the Brazilian economic crisis, which started in 215 (see Figure 8). Figure 8: Brazilian consumption profile at-home vs. out-of-home, 23-218 1% 17% 23% 27% 29% 32% 32% 8% share 6% 4% 83% 77% 73% 71% 68% 68% 2% % 23 26 29 212 215 218 Home Out of home Source: Euromonitor, Rabobank 218 Retail sales of specialty coffee primarily take place in stores with a premium positioning, such as delis and some supermarkets that conduct in-store marketing (tasting). Capsules play an important role in the retail channel and are often the first step for consumers who start buying specialty coffee. The horeca channel, led mainly by coffee shops, has greater relevance in big cities, but has expanded nationally in recent years, with some strong premium-coffee chains expanding in the Brazilian market. The most well-known chain is Starbucks, but franchises such as Café do Ponto (a JDE brand), Suplicy Cafés Especiais, Octavio Café, and São Braz are also relevant. 5/8 RaboResearch Brazil Wakes up to Premium Blends October 218

However, most premium coffee shops are independent, representing around 65 percent of the Brazilian coffee shop market. The main differentiator between coffee shops is the customer experience, such as the atmosphere and attention to detail. Some even offer the option to choose the method of brewing and the bean's origin (geography). Coffee shops have developed in tandem with sales developments (in-store vs. online) and the evolution of brewing accessories. In recent years, consumers have started to use e-commerce more frequently, and as a result, not only coffee chains, but also independent coffee shops have invested in these digital platforms. E-commerce is becoming a critical platform for coffee shops not just for sales of coffee and accessories, but also for customer relationship management (CRM) and subscription services. Café Orfeu, Suplicy Cafés Especiais, and Octavio Café are some examples of relevant chains that have invested in these platforms. Independent coffee shops, such as Academia do Café, Cafeteria Dulcerrado, Coffee Lab, and Sofá Café, have also made significant efforts to improve their digital platforms. Hurdles and opportunities Despite the positive outlook, there are some bottlenecks in the Brazilian premium coffee market. Pricing remains a key barrier to growth. Brazil is still an emerging economy with major social inequalities. As a consequence, consumption growth of more expensive premium coffees is being driven by a relatively small segment of the population. The spread of coffee consumption throughout the country is another challenge. Coffee culture is not nearly as widespread in the more tropical areas in the north and north-east as it is in the cooler regions in the south and south-east. Lastly, Brazil is still recovering from its recent economic recession, which has negatively affected the whole chain of specialty coffees from the coffee itself to accessories for at-home consumption. Despite these hurdles, the specialty-coffee market continues to show solid growth. The steady stream of new product launches and innovations has helped this segment perform very well. Furthermore, media coverage of the growing coffee culture has taken up more space on television and especially on social media. The investments in innovation targeting a new generation of customers interested in new products (focusing on quality, traceability, and practicality) are driving positive trends in the specialty-coffee sector. This growing demand is opening up new investment opportunities for coffee companies in the Brazilian market. Coffee pods: still a good market! So far, coffee pods have been one of the main formats through which consumers are introduced to specialty coffee. In recent years, it has mainly been the established coffee companies in Brazil that have invested in this space... but there are still opportunities. Although consumption growth is slowing, the coffee-pod format remains quite healthy and has a high added value. It s also an excellent format to introduce a brand to the market, quickly increasing its popularity. In June, Melitta announced it would produce Nespresso-compatible coffee pods for the Brazilian market and installed a production line at its plant in Avaré, São Paulo. Brazilian consumers should look for designation of origin Brazilian consumers are learning about specialty coffee, but still aren t very aware of social (such as UTZ or Fairtrade), environmental, or health certifications or geographical indications (specific 6/8 RaboResearch Brazil Wakes up to Premium Blends October 218

region of production). However, it is only a matter of time until these new consumers begin to seek these out more proactively. As the market develops, it will be very important for coffee companies to look for certified partners for their supply. They will need to attain certificates for the origin of the coffee and invest in communicating these certifications to consumers. In recent years, many coffee-producer associations have started to work with geographical indicators. The main examples of this are Alta Mogiana, Café do Norte Pioneiro do Paraná, Matas de Minas, Cerrado Mineiro, Mantiqueira de Minas, Cafés das Montanhas do Espírito Santo, Pinhal, and Café do Sul de Minas. Digital platforms need more investment Younger consumers are increasingly buying coffee and coffee accessories online. The use of digital platforms in Brazil is growing, but there are still opportunities. Companies can invest in user-friendly digital platforms, form partnerships to distribute their products through online sales channels, and create efficient CRM tools. Some large producers and/or associations may look to verticalise their business and sell their coffee directly to consumers, using online channels or by opening specialised coffee shops. For instance, Dulcerrado Cafés Especiais do Produtor is an initiative of the Cerrado Coffee Grower Federation that sells the coffee produced by its members, with certification of origin ( Cerrado Mineiro ), either through the coffee shop it owns (located in Patrocinio, Minas Gerais) or via its online store. The initiative also offers consumers the option to subscribe and receive shipments on a regular basis. Out-of-home consumption: coffee shops are an attractive opportunity The Brazilian economy is recovering from the recent crisis, and out-of-home consumption is expected to return to growth. Investing in coffee shops presents a good opportunity, mainly in the north and north-east region, as that market has not yet been developed. Havanna, an Argentine confectionary company, has invested in Brazil by franchising coffee shops (47 in total), and it is prioritising the opening of 5 new coffee shops in the north and north-east region. In Brazil, many local companies have expanded by opening coffee shops, even though coffee isn t their core business. Many of these non-specialist coffee shops still do not work with specialty coffee, and they could be good potential partners for specialty-coffee companies. Large, medium, and small players will continue to invest in expanding their portfolios by adding products that are different in terms of category, origin, and packaging. This means the specialtycoffee market in Brazil is getting hotter and hotter. 7/8 RaboResearch Brazil Wakes up to Premium Blends October 218

Imprint RaboResearch Food & Agribusiness far.rabobank.com Guilherme K. K. Morya Analyst Beverages guilherme.morya@rabobank.com +55 11 553 726 218 All rights reserved This document is meant exclusively for you and does not carry any right of publication or disclosure other than to Coöperatieve Rabobank U.A. ( Rabobank ), registered in Amsterdam. Neither this document nor any of its contents may be distributed, reproduced, or used for any other purpose without the prior written consent of Rabobank. The information in this document reflects prevailing market conditions and our judgement as of this date, all of which may be subject to change. This document is based on public information. The information and opinions contained in this document have been compiled or derived from sources believed to be reliable; however, Rabobank does not guarantee the correctness or completeness of this document, and does not accept any liability in this respect. The information and opinions contained in this document are indicative and for discussion purposes only. No rights may be derived from any potential offers, transactions, commercial ideas, et cetera contained in this document. This document does not constitute an offer, invitation, or recommendation. This document shall not form the basis of, or cannot be relied upon in connection with, any contract or commitment whatsoever. The information in this document is not intended, and may not be understood, as an advice (including, without limitation, an advice within the meaning of article 1:1 and article 4:23 of the Dutch Financial Supervision Act). This document is governed by Dutch law. The competent court in Amsterdam, the Netherlands has exclusive jurisdiction to settle any dispute which may arise out of, or in connection with, this document and/or any discussions or negotiations based on it. This report has been published in line with Rabobank s long-term commitment to international food and agribusiness. It is one of a series of publications undertaken by the global department of RaboResearch Food & Agribusiness. 8/8 RaboResearch Brazil Wakes up to Premium Blends October 218