Financial Daily from THE HINDU group of publications
Sunday, Jul 07, 2002
Markets - Recommendation
Tata Tea: Hold/Avoid fresh exposures
THE Tata Tea stock has been on a power thrust over the past few days and now trades at Rs 205. This is due mainly to indications of a early turnaround at Tetley, the British tea major acquired by Tata Tea in 2000. Apprehensions about the high cost of the acquisition and the demands the loss-making Tetley would place on Tata Tea's finances, had led to a collapse of the Tata Tea stock price over the past couple of yearsfrom Rs 560 in the beginning of 2000 to Rs 120 in October 2001.
Tetley: On road to profitability
With Tata Tea's 2001-02 balance-sheet yet to be published, the full financials of the Tetley group are as yet unavailable. However, numbers provided by Tata Tea suggest that Tetley is indeed on the road to profitability. The Tetley group appears to have improved both its profitability and operating cash flows in 2001-02.
In 2001-02, Tetley made market share gains in the key markets it operates in. Tata Tea claims that the Tetley group recorded a £8.4-million increase in its earnings before taxes and amortisation in 2001-02. In 2000-01, Tetley GB (an 85.7 per cent subsidiary of Tata Tea which serves as the special purpose vehicle representing the Tetley group) reported earnings before taxes of £0.57 million. This suggests that the company's earnings, after interest costs, are now positive.
Boost from debt restructuring
A reduction in the interest cost appears to have played a key role in this turnaround. During the year, Tata Tea injected £30 million into the Tetley group (£29 million by way of convertible loans and £1 million as equity). This was used to replace the high-cost debt, resulting in interest cost savings of £2.7 million in 2001-02. A further saving of £7.3 million is expected in 2002-03 from the debt restructuring exercise, which could boost Tetley's profitability in 2002-03. Any reduction in the interest cost has immense potential to boost Tetley's profitability.
In 2000-01, Tetley's operations generated profits before interest costs and goodwill amortisation. But it made net losses because interest costs at £26.12 million, were a shade higher than the operating profits (£25.55 million).
However, Tetley's quick return to profitability is also on account of a decision to refrain from amortising goodwill (which represents the premium paid on the acquisition of Tetley). If the goodwill carried on Tetley's balance-sheet is to be amortised over a 20-year period, this would have resulted in an annual charge of £11.97 million, which would have delayed Tetley's turnaround (on the balance-sheet). The company has taken a view that since the goodwill represents the value of the Tetley brand, any charge will be taken only in the event of impairment of the value of the brand. If the company has any reason to revise this opinion at a later date, this may result in a big one-time write off for Tetley.
Domestic sales: The real problem
It appears that Tetley will not turn out be an albatross around Tata Tea's neck as feared earlier. However, this may not be reason enough for a sustained uptrend in the Tata Tea's stock, for all is not well with Tata Tea's core operations. For 2001-02, Tata Tea reported a 28.1 per cent drop in its net profits to Rs 71.96 crore, on the back of a 7.3 per cent slump in its net sales to Rs 779.43 crore.
Part of the drop in net profits is on account of a fall in non-operational incomes, in the form of dividends from investments and profits from sale of shares. Tata Tea's profits for 2000-01 benefited from a substantial dividend from its investment subsidiary, Bambino Investments and Trading Company. The subsidiary had then got a windfall from the sale of a strategic stake held in ACC. Bambino Investments has, with effect from October 2001, merged with Tata Tea. But if the impact of non-operational incomes is netted out, Tata Tea has still suffered a 20 per cent drop in its sustainable net profit (Rs 42.61 crore for 2001-02).
The drop in the company's sales (this is the second consecutive year when sales declined) is mainly the result of the shrinking market for packaged tea and the falling exports. Exports of bulk and packet tea have traditionally acted as the safety valve for excess domestic output of tea. However, competition from better priced and superior quality teas from Sri Lanka and Kenya have restricted Indian tea exports over the past couple of years.
Shrinking market share
This has led to a substantial build up of carry forward stocks in the Indian market, pressuring auction prices. The selling prices of the major brands of packed tea have not reflected the sharp decline in wholesale prices. Packed tea manufacturers have been losing customers to the slew of unbranded and regional players, which have offerings priced at much lower levels. As a result of these factors, the packet tea market is estimated to have shrunk by around 7 per cent in 2001. This follows two consecutive years of shrinkage in market size. Tata Tea too has lost market share, from 20.8 per cent in March 2001 to 18.8 per cent in March 2002. Though this phenomenon is common to all the major players in branded tea, including HLL, this does not make it any less disturbing.
Tata Tea has attempted to counter this trend by launching its own offering Agni Sholay at the lowest end of the price spectrum. It has also broadened its product portfolio (which earlier addressed the mid-priced segment alone) to launch premium brands Temptations and Tetley to compete with HLL's Yellow Label and Taj Mahal. But these initiatives have been kicked off in an intensely competitive environment and may entail fairly heavy brand building expenses. Already, Tata Tea has attributed part of its net loss of Rs 16.33 crore in the March 2002 quarter to heavy brand-building expenses.
If falling tea prices have hurt Tata Tea's profitability, a revival in prices may not necessarily rejuvenate it. Even if tea prices climb on account of a fall in domestic output (in 2002), the players in the branded tea market may find it an uphill task to wrest back market share lost to regional players, now that price-sensitive consumers have had a taste of the cheaper offerings.
While there appears to be limited scope for a resurgence in sales growth in the near term, cost-savings from better integration of its operations with Tetley and the possibility of a higher offtake of packet tea for Tetley's operations could offer hope for Tata Tea's earnings this fiscal. This apart, one key factor which may work to Tata Tea's advantage would be its war chest.
Apart from holding around Rs 100 crore in cash, Tata Tea has also acquired an investment portfolio of around Rs 112 crore (market value as on March 31, 2001), from the merger of Bambino Investments in 2001. This includes strategic stakes in several Tata group companies such as Tata Chemicals, Tata Investment Corporation and Tata Sons, for which the actual value is likely to be much higher than captured in the books. Given the possibility of windfall gains from these holdings, this enhances the comfort levels associated with the company, for financing additional brand building expenses or a further funds infusion into Tetley.
The Tata Tea stock price discounts the latest per share earnings of Rs 12.80 by around 15 times. This is relatively low valuation compared to other FMCG companies and may cushion the stock against a very sharp slide. Given the 70 per cent appreciation in stock price since October 2001, investors need not contemplate fresh investments in the stock at these levels.
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