Consolidation, particularly in South India, is the way out, but the assets are overpriced.

The year 2011 should have been a rewarding one to the tea industry, as the output was up by three per cent against a backdrop of stable prices.

Yet, according to the Chairman of the Indian Tea Association C. S. Bedi — the largest planters’ lobby in the country — nearly half the country’s tea industry seems to have struggled for survival in 2011, as its produce fetched an unviable price of less than Rs 100 a kg.

The viability concern continues in 2012, even as tea prices are now rising in the face of improved domestic demand. Bedi doubts if the prices are high enough for the majority of estates to be able to offset crop loss and spiralling costs.

“This (2012) is the costliest year in the history of tea industry,” Bedi says, pointing to the 22 per cent rise in wage bill and the three-fold increase in fuel cost.

BIG-SMALL DIVIDE

But, there is something more to this story. Nearly a fifth of the 1,700-odd relatively large estates (over 10 hectares) in the country — which had duly invested to ensure quality — got a higher price of Rs 140 a kg in 2011 for their teas. And, large players, such as McLeod Russel, are expecting the good times to continue in 2012.

No one is happy with the cost increase or satisfied with the realisation. But Rs 23-25 a kg rise in tea prices makes Kamal Baheti, CFO of McLeod, confident of ending the year on a positive note. The company has hedged against climate risk by spreading its operations across different geographies, both in and out of the country.

“Players with extremely localised operations, for example in the Assam valley, may suffer due to crop loss impact,” he says.

It is clear that the rules of the game are turning in favour of large capital, which produces teas from a diversified asset portfolio. This is in sharp contrast to the smaller players, largely operating out of one or two estates and vulnerable to increasing uncertainties — be it a pest attack, climate issues, and spiralling labour or energy costs.

Yet, the fact is that the tea industry is ruled by smaller players. For an industry with a combined turnover of Rs 5,000-6,000 crore, there are as many as 500 players controlling 1,700 odd ‘large’ estates.

SOUTH INDIA’S PROBLEM

The problem is more acute in South India which has a limited presence of large corporate houses.

It can be argued that the fragmented nature and stretched finances of planters in South India is telling on the ill health of the region’s plantations. As against a national average of 38 years and North Indian average of 35 years, the average tea bush in the South is as old as 52 years — making it more susceptible to climate risks, among other factors.

Theoretically, this creates a perfect situation for mergers and acquisitions, leading to consolidation of plantations in favour of investors with deep pockets. With a greater access to capital, these investors wouldn’t mind going in for the necessary investment in the plantations, to make the most of a rising curve in tea prices since 2007.

WHY NO M&A

McLeod Russel, the world’s largest tea producer, for example, is a staunch believer in a brighter outlook for tea industry in the years to come, and is keen to grow. “Think of any industry, control over natural resources proves vital,” Managing Director Aditya Khaitan keeps saying.

The black tea producer is on the lookout for suitable acquisition opportunities overseas, but not in India. It finds Indian assets overvalued, compared with the rate of return.

To arrive at valuation of a plantation asset, tea industry sets the value of every kg of tea and multiplies the same with annual production from the particular estate.

Alongside the industry’s complaints of low returns, the average valuation of the tea estates in India has increased from approximately Rs 150 a kg in 2005 (when Khaitan last acquired estates) to Rs 400-450 a kg at present. This rise in valuation is simply not in tune with the 80-90 per cent rise in tea prices during the period.

Besides, most the assets on the block are of poor quality. In many cases, the existing owners have defaulted on paying statutory dues, leading to hidden liabilities.

Bedi, who manages Rossell Tea, a mid-sized quality producer, for example, doesn’t find merit in acquiring sick or closed gardens.

He agrees that there is little scope for setting up large greenfield estates in India. And, acquisition is the only available option for serious players to grow. But, the long gestation period of making such sick assets viable vis-à-vis the final cost of acquisition makes such estates unattractive.

WAIT AND WATCH

The catch, Baheti feels, lies in realistic asset valuation linked to profitability and yield. The age-old practice of linking the prospective rise in tea prices to asset value is no longer viable in an environment marked by uncertainty and requirement of large capital.

Planters in Africa are coming to terms with this new reality, Baheti argues. He hopes that the model is here to stay.

In the absence of proper asset valuation, large capital is likely to increase its production profile through outsourcing from ‘small growers’. This is already happening.

Efforts are now on to usher in greater discipline in such outsourcing, and ensure consistency in quality.

The initiative, as and when it gains strength, may add to the pressure on small financially stretched players producing commoner varieties.

This will impact asset valuation, unless, of course, the government allows real-estate development in plantation estates.

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(This article was published on November 21, 2012)
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