Tata Tea: Buy

Recommendation: Buy

Reshma Krishnan

THOUGH the tea industry might be going through a difficult phase of transition, investors should consider taking an exposure in Tata Tea's stock.

This is in view of the company's current market levels, its focus on packet tea, and its global portfolio that includes Tetley -- the largest tea brand in the world.

Tata Tea is the largest integrated tea manufacturer in the world. Integrated in the sense it is involved in all phases of the value-chain and, therefore, incurs both benefits and hazards. Since the company owns gardens, it has control over both the quality and the quantity of the tea, without having to depend on the open market. But it is also a disadvantage in view of the TMC (Tea Marketing Control) Act that requires companies to put a large percentage of the tea they produce through auctions; this overrides any gains from owning the tea. This applies to only tea that is sold bulk and not packaged tea.

The outlook of the industry is uncertain in general. The year 2000 was not good for the industry as the first-half saw falling prices, rising production and dropping exports. While prices have recovered marginally, they are still way below their 1999 levels. The average prices of tea at auction centres have also been falling from a high of Rs 81.62 a kg in October 1999 to Rs 47.82 in April 2000 -- a fall of 41 per cent. This can be attributed to imports from Sri Lanka and excess production. Prices have since improved marginally to Rs 64.23 in September 2000, still 18 per cent lower than the corresponding period.

The effect of the industry's poor performance on Tata Tea's financials for 1999-2000 has been significant. Its profit has declined 3 per cent from Rs 128.75 crore in 1998-99 to Rs 124.63 crore in 2000. Sales from operations increased by 5.4 per cent from Rs 874.23 crore to Rs 922.12 crore in 1999-00. `Other income' rose from Rs 16.48 crore to Rs 48.06 crore, mainly on account of the profits from the sale of its ACC stake. This tempered the decline in earnings. Reasons for the fall in profits can be attributed to the drought in North India and falling prices in the South. Operating profit margins also declined from 25.2 per cent to 21.8 per cent.

However, the financials for the six months ended September are not impressive, but acceptable considering the current industry situation. Income from operations is down 5.5 per cent to Rs 419.95 crore from Rs 444.84 crore the previous year. Staff costs have increased, because of the industry's labour intensity and the wage settlement. The overall expenditure has decreased, mainly in the fall of consumption of raw materials as tea prices have fallen. Margins have gone up to 28.6 per cent from 27.2 per cent. While the topline growth has declined, the bottomline is still stable with a marginal increase of 3.31 per cent to Rs 74.70 from Rs 72.30.

The tea industry is cyclical in nature, and though profits have declined on account of falling prices, prices seem to be recovering. Also, a fall in commodity prices affecting Tata Tea's profitability appears unlikely as the company's focus is shifting towards packet teas, which are not affected by auction prices. For instance, the proportion of sales from packet tea moved from 24 per cent in 1998-99 to almost 35 per cent in 2000.

Another reason to stay invested in the stock is that though the industry scenario is uncertain, Tata Tea, through its Tetley acquisition, has a ready export market in North America, Europe and Australia. Tetley is the world's second largest tea brand and leads the British tea bag market with a share of 22 per cent. This tea giant will act as a crucial export market for Tata Tea. Tetley also complements Tata's strategy of shifting focus from its plantation to the consumer. These factors should pay off over the long term.