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Alagappan Arunachalam

The company's move to phase out ownership of plantations is a long-term positive.

TATA TEA shareholders can retain their holdings of the stock. At the current price of Rs 500, the stock trades at about 12 times its likely consolidated per share earnings for FY-05. The company's margins could, however, come under pressure, as it may not be able to pass on the effect of higher prices to customers — institutional and retail. But, given its position of strength and imminent favourable changes to its business profile, price weaknesses, especially linked to broad market trends, can be used to accumulate the stock.

The cost of tea cultivation and production in India is among the highest in the world. As Tata Tea owns/leases a large number of plantations, it has had to suffer losses in this business. This has cut into profits from its branding and marketing initiatives. In this context, the company's plans to move out of plantations and focus on marketing branded tea augurs well. This is in line with the business strategy that Tetley, owned by Tata Tea, has followed at the global level.

The proposed restructuring of the ownership of Tata Tea plantations is likely to be a positive from a long-term perspective. As a few of them are to be sold, it is likely to generate sizeable cash flows and profits. In view of the fact that Tata Tea's leasehold properties are to be transferred to a company in which employees would hold a controlling stake, supplies are unlikely to be at risk.

This arrangement is also likely to lead to a substantial reduction in labour costs besides eliminating the risks associated with the management of a large labour force. The divestiture of its tea plantations along with a declining debt-equity ratio would place Tata Tea in a better position to raise funds at attractive rates to finance growth through acquisitions.

The restructuring of the debt of Tata Tea (GB), UK, which holds the group's stake in Tetley, has led to a reduction in interest cost. Tata Tea GB has lowered its debt-equity ratio to 1.6:1 and the weighted average interest rate has declined to lower levels unlike the situation that prevailed earlier.

As the financial costs associated with the acquisition have been a major drag on profitability, the reduction in interest costs is likely to shrink payback period. As the debt burden is cut further, Tetley would be well-placed to foray into newer markets.

The latter assumes importance as Tetley has been improving its share in a declining branded tea market at the global level. Tata Tea derives about 80 per cent of its revenues in India from its branded tea business.

The local and regional players in the branded tea business are expected to lose their cost advantage due to rising tea prices, which are at a five-year high. A pest attack affected the tea crop in South India, and thus expected to further push up prices.

Tata Tea's consolidated financials would also benefit from the improved performance by subsidiaries such as Tata Coffee.

Tata Coffee recently bagged an order from Starbucks, the largest chain of coffee shops in the US; the deal provides for a substantial premium over the market price for coffee beans. Its deal with Starbucks is expected to be of a long-term nature.

Tata Tea recently launched value-added products, new packaging initiatives and flavoured tea brands to shore up its market share. It plans to acquire businesses rather than brands, introduce speciality and green teas and foray into new markets.

The enhanced thrust on retail customers is also likely to improve profitability; it would shift its focus away from institutional sales, which provide lower margins.

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