The Hindu Business Line : Tata Coffee: Buy

The Eight O' Clock (EOC) acquisition, instant coffee expansion plans and the turnaround of the recently acquired tea plantations lends confidence to the stock.

Investors can consider taking exposure in the Tata Coffee stock, which trades at about 18 times its 2005-06 earnings. The Eight O' Clock (EOC) acquisition, instant coffee expansion plans, and the turnaround of the recently acquired tea plantations augur well for the stock.

The EOC acquisition provides Tata Coffee access to brands, while the Tata Tea distribution network provides its access to a wider geographical spread.

The company is planning a rights offer of partly convertible debentures (PCD) to partly finance its EOC acquisition and other capacity expansion requirements.

The PCD will have a face value of Rs 400, with Rs 250 convertible into equity on allotment and the debt component to be redeemed from the fourth year.

Tata Coffee derives a chunk of its revenue from coffee growing, processing and instant coffee manufacturing. Though the company has for long been susceptible to trends in coffee prices, the degree of this susceptibility is set to decrease with the company foraying into retailing and expanding its instant coffee operations.

Though prices are likely to remain flat on the back of strong inventory levels in major consuming countries, earnings growth for Tata Coffee would flow from its instant coffee and retail business.

Instant coffee business

Tata Coffee plans to focus on its instant coffee business. Higher value-addition from this segment is expected to be an earnings growth driver in the medium term. With this business providing higher margins and a respectable return on capital employed, Tata Coffee plans to increase the capacities of its existing instant coffee business. At present, the company operates two facilities with a total capacity of 4,500 tonnes. Volumes of its instant coffee business is set to rise with Tata Coffee setting up a 2,000 tonne plant.

Margins of this facility are likely to be higher as freeze-dried coffee commands higher realisations than spray dried-coffee.

Eight O' Clock Coffee

In June, Tata Coffee entered in to an agreement for Eight O' Clock Coffee (EOC), a coffee manufacturer and distributor in the US from Gryphon Investors for $220 million (about Rs 1,000 crore).

EOC is among the larger players in the gourmet coffee segment and among the top coffee retailers in the US. With EOC under its fold, Tata Coffee has access to a spectrum of established brands. With Tata Tea continuing its acquisition spree, prospects are bright for Tata Coffee as it could pursue other markets by leveraging Tata Tea's distribution network in countries other than the US.

Tea business

With intent to diversify its risk profile, Tata Coffee acquired the South Indian tea plantation business of its holding company, Tata Tea, at the start of 2006. The decision is paying off with the company's tea division having reported an earnings contribution in the first quarter of FY-07 despite lower prices compared to a year ago. With better Kenyan production figures and global tea prices heading southwards, sustaining earnings growth could be difficult in the near term. However, over the medium term, this division is expected to retain its profitability, with scope for a reduction in its growing costs.

Pepper, vanilla and timber, which are intercropped with coffee trees, contribute marginally to Tata Coffee's revenue. Though revenues and earnings growth from these products are unlikely to be substantial, they provide the company an additional stream of revenue. Tata Coffee also cultivates cardamom, which helps in diversifying its risk profile. The company also has a presence in the vending business branded as Jiffy and coffee retail business in India through its Mr Bean outlets.

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