The Hindu Business Line : McLeod Russel Williamson Tea: Sell

Investors can consider divesting from McLeod Russel and Williamson Tea Assam, considering the sharp appreciation of the stocks on the back of a much-hyped drought in Kenya.

The African nation, which is among the largest exporters of tea, recorded a sharp drop in production in 2006 first quarter. Although international prices of tea rose at a fast clip, helped by the Kenyan drought factor, there has been little alignment in the domestic market.

Domestic prices continue to remain subdued with Pakistani buyers unwilling to pay Indian exporters on a par with their Kenyan counterparts.

Domestic producers are unlikely to benefit from the drought situation as production figures in Kenya were up 4 per cent in April. Compounding the woes of the Indian tea producers is the higher production figures reported in Sri Lanka, another large tea exporter.

Consolidation

McLeod Russel, among the largest bulk tea producers in India along with Williamson Tea Assam and Doom Dooma Tea Company, produces about 72 million kg.

Though McLeod's Rusell's acquisitions have helped it garner a chunk of the market, this consolidation is unlikely to play a significant part in generating higher realisations in a market that is largely dispersed.

Exports

The B. M. Khaitan group plans to tap the Pakistani market, which sources a large part of its requirements from Kenya. This market would be difficult to break into, given the interdependence of the two economies for rice and tea.

The Khaitan group, which proposes to increase its focus on the European market, faces competition from Kenyan tea producers. European buyers have traditionally been sourcing a large part of their requirements from Kenya.

Even the realignment of the import duty structure in the EU is unlikely to tilt the scales significantly in favour of the Indian tea industry.

Export prospects to Egypt and West Asia also appear to be dull as proximity to these markets helps Kenyan tea score over Indian tea.

Proposed merger

Though the proposed merger of Doom Dooma Tea and the zero-debt Williamson Tea Assam with itself is likely to reduce McLeod's Rusell's debt-equity ratio, but it would still not be down to comfortable levels.

After the proposed merger, McLeod Russel is likely to end FY-06 with debt in excess of Rs 400 crore. A high leverage factor is a cause of concern for McLeod Russel and Williamson Tea Assam, which operates on thin margins.

High labour costs have been a cause of worry for the Indian tea industry. Employee costs, which account for about 45 per cent of McLeod Russel's and Williamson Tea Assam's operating expenditure, are unlikely to come down, given the bargaining power of workers in the manpower-dominated industry.

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