Chocolate Trades

03/19/2015 7:00 am EST

Focus: STOCKS

Jeffrey Hirsch

Editor-in-Chief, The Stock Trader's Almanac and Almanac Investor

Cocoa tends to begin a seasonal decline in early to mid-March through the end of May, notes Jeffrey Hirsch, editor of Stock Traders Almanac; here, he looks at ways to trade that trend.

Cocoa has two main crop seasons. The main crop from the Ivory Coast and Ghana in Africa accounts for approximately 70% of the world production and runs from January through March.

As inventories are placed on the market, this has a tendency to depress prices, especially when demand starts to fall for hot chocolate drinks and chocolate candy in the spring and summertime.

After briskly rebounding from its late-January/early-February low, cocoa’s momentum has stalled with technical indicators signaling overbought conditions just ahead of typical seasonal weakness.

Futures traders could consider an outright short position. Stock and ETF traders could try to short iPath Pure Beta Cocoa ETN (CHOC), however, it is not liquid. (Selling on or about March 13 and holding until on or about April 16 has been a winner in 32 of the past 42 years.)

Another possibility, with plenty of liquidity and possibly less risk is Hershey Foods (HSY). When cocoa prices rise, Hershey’s price tends to decline and the opposite often holds true as well.

However, HSY is also subject to currency exchange rates as a global company. A surging US dollar will inevitably impact earnings and share price even when HSY’s input costs decline with falling cocoa.

More interesting is Rocky Mountain Chocolate Factory (RMCF). With a market cap around $85 million, this is definitely a small-cap company. 

Headquartered in Durango, Colorado, it operates as a confectionery franchisor, manufacturer, and retail operator.

RMCF’s valuation is reasonable with a P/E of 17 and a price to sales ratio right around 2.  Cash on hand and debt are also reasonable. They also pay a respectable dividend (3.4% yield) and have a share buyback program.

The company does have some foreign operations, but the majority of their operations are in the US, which mitigates much of the potential damage a stronger dollar could cause.

The stock could be considered on dips below $13.62. If purchased, a stop loss of $12.60 is suggested. Falling input costs, reasonable valuation, solid growth prospects, and reduced concerns about the stronger dollar make RMCF attractive.

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