Tata Tea: Hold

Recommendation: Hold

Reshma Krishnan

TATA Tea is beginning to feel the effect of a shrinking and difficult tea market.

This is clearly reflected in its second quarter performance and might indicate that the road ahead is not smooth for the company. It was impossible to sustain the growth in the first quarter as tea prices remained depressed and volumes shrank.

The quarter ending September 2001 was mediocre at best. Topline growth was negative. Sales fell 18.20 per cent to Rs 186.01 crore from Rs 227.40 crore in the corresponding previous period. There was, however, evidence of better control over expenditure as expenses fell by a sharper 21.30 per cent to Rs 132.36 crore. Operating profits fell by a smaller percentage to Rs 53.65 crore from Rs 59.21 crore. There was a significant rise in operating profit margins to 28.84 per cent from 26.04 per cent.

Tata Tea's profit after tax, excluding the dividend income of Rs 18.95 crore, fell 7.47 per cent to Rs 33.44 crore (Rs 36.14 crore). The steep rise in dividend income was ascribed by company officials to an interim payout by Bambino Investment and Trading Company -- the tea major's 100 per cent investment subsidiary approved for merger with Tata Tea last month-end.

Focussing on the topline performance first: Sales was the biggest casualty of the quarter, mainly due to industry factors. The tea sector is in its second year of depressed prices, and realisations are falling. Therefore, the income from a similar volume of tea sold last quarter was much lower. There is also a tremendous over-production in the domestic CTC market, leading to a depression in prices.

The company also claims to be losing market share to regional brands. According to the company, its market share fell 0.4 per cent in April-September 2001 and this is because of the price strategy of the regional players to oust it out of the market by selling at lower prices.

Exports were also hit industry-wide with volumes falling 9 per cent for the January-August 2001 period. The domestic market is also growing extremely slowly; tea consumption is estimated to have grown by only 1.5 per cent in the last year. With a shrinking market and declining auction prices, it is not surprising that Tata Tea's performance has been less than satisfactory.

The falling auction prices have, however, partly led to an increase in the operating margins as the company has left its retail prices unchanged. Therefore, its packaged tea division has acted as an efficient buffer on profitability. Unfortunately, since this division only accounts for about 30 per cent of the company's total sales, it does not contribute substantially to volumes.

The news appears to be better on Tata Tea's crossborder subsidiary -- Tetley -- whose performance has improved. Tetley's operating profits increased 24 per cent on improved margins. The infusion of funds into the company lower its debt-equity ratio to 1.8:1 from 3:1.

This is good news for Tata Tea that is looking at an uncertain future, both from domestic and overseas angles. On the one hand, while consumption is saturating on the domestic front, exports appear set for troubled days ahead. The latter are expected to decline over the next couple of years because of increased competition from China, Kenya and Sri Lanka.

Therefore, Tetley seems to be Tata Tea's only silver lining. Every year, Tetley sources 55 million kg of tea worldwide, with eight million kg coming from India. Yet, it sources only one million kg from Tata Tea. The real benefit will be realised when and if Tetley begins to source more of its tea from Tata Tea. This would then shore up the latter's falling exports.

For the next quarter, Tata Tea could again be looking at some one-time cash inflow. The company decided to divest its 50 per cent stake in Tata NYK joint venture. A 40 per cent stake has been sold to the JV partner and the company will receive Rs 7.69 crore in Q3 for sale of this. The balance 10 per cent will be divested at an "opportune time''. Also, Bambino Investment and Trading Company was merged with Tata Tea with effect from October 2001. There should be a positive impact on the bottomline.

There is no evidence that points to an increase in sales for the third quarter. Everything points to a tough 2001-02 for Tata Tea. The annualised earnings per share stands at Rs 17.46. The stock recently surged from around Rs 120 to Rs 170. This may limit the scope for near-term capital appreciation and investors may hold the stock.