Stocks prices of tea plantation companies McLeod Russel and the Goodricke Group, gained 5-9 per cent last week, outperforming the BSE FMCG index, which gained two per cent and the Sensex (nominal gain of 0.2 per cent). This increases their year-to-date gains to 30-50 per cent, mainly driven by improving tea prices. Analysts expect tea prices to tread higher due to production lagging a rising demand and this looks sustainable in the long term. While this is positive for the sector, most analysts are bullish on McLeod Russel due to its size and geographical diversification.
According to sector estimates, production in Assam, which forms 51 per cent of national output and 13 per cent of global production, is down due to deficient rainfall. Says Subrata Basu, president (tea exports and marketing), Jayshree Tea and Industries, “The weather is dry in the northeast and there is no rain, except in some patches. Production in March was 40-50 per cent lower year-on-year and the same in April is estimated to be lower by at least 20 per cent.”
It is a similar case in south India, which is witnessing a prolonged dry spell. Though it is too early to conclude that production will decline in calendar year (CY) 2012, since the first flush forms just 10 per cent of total domestic tea production, in case the shortfall is not overcome in the coming months, prices, which remained firm in 2011, would rise further. Currently, average prices are ruling higher by Rs 40-50 per kg at the auction centres (at about Rs 220).
| MIXED TREND | ||
| In Rs crore | McLeod | Goodricke |
| Net sales | 946.7 | 393.8 |
| % chg y-o-y | 11.3 | 10.5 |
| Op. profit | 416.8 | 87.0 |
| % chg y-o-y | 10.0 | -9.1 |
| Net profit | 378.0 | 63.4 |
| % chg y-o-y | 7.1 | -6.5 |
| Figures are for nine months ended December 2011; Source: Companies | ||
Sustainable
Kamal Baheti, chief financial officer, McLeod Russel, says, “We expect FY13 to be good for tea prices, thanks to the lower inventory of last year and rising consumption.” Analysts, too, sound optimistic. Prasad Deshmukh, analyst, Bank of America Merrill Lynch, in a February 27 report, says he expects a strong season for tea prices in CY12, led by continuing global shortages (eight per cent of annual demand), lower inventory in India and lack of recovery in the Kenyan crop from last year’s levels.
India’s production has been stagnant over three years, while consumption has been rising three to four per cent yearly. Revati Kasture, head of research at Care Research, expects India’s output to grow at an average annual 0.42 per cent between years 2012 and 2014, and reach a billion kg by end-2014. This trend of stagnant production and higher consumption is likely to continue for some years. According to Baheti, the gestation period for a new plantation to come up is four to five years. Hence, any substantial increase in production in the short term looks difficult.
McLeod Russel, India’s largest producer, with 59 gardens (53 in India and six in Uganda) and three factories in Vietnam producing 100 million kg annually, is expected to be the biggest beneficiary of improving prices. Their strategy of acquiring tea gardens in Africa also augurs well.
Says Sanjay Manyal, analyst, ICICI Direct, “The company’s bids for two tea gardens in Rwanda will more than triple production from the country and the acquisition would notably contribute to its earnings, as margins from the Rwanda gardens are higher at 50 per cent, compared to McLeod’s 28 per cent.”
Excluding this bid, the company’s sales are expected to grow at a compounded annual rate of 11 per cent over 2010-13 and net profit by 17 per cent. Growth in profit could have been faster but for a wage rise in its Assam gardens.
With the rise in prices, the stock has risen from Rs 181 on January 30, 2012, to Rs 280, and looks fairly valued (price/earnings of nine times FY13 estimated earnings).
Others
Goodricke will also gain from higher prices. However, analysts say McLeod continues to be a better investment, as the size and economies of scale matter in a commodity business like this. Goodricke’s revenue is less than half of McLeod, while the latter’s profits are six-seven times larger. While sales grew 11 per cent each for Goodricke and McLeod in the nine months ended December 2011, both showed exactly opposite profit trends, with Goodricke disappointing and McLeod cheering investors.
Further, McLeod is relatively more diversified (geographically) than Goodricke. However, these factors are also reflecting in Goodricke’s lower valuations. Based on annualised profits for the nine months to December 2011, the PE works out to 3.5 times. It also has a healthy dividend record, with the last dividend translating into a yield of three per cent. In this backdrop, investors with some appetite for risk may consider it.
Jayshree Tea & Industries, which derives around 75 per cent of revenue and close to 80 per cent of profits from the tea business, would also gain.
However, the gains will be limited, as it is also present in sugar and chemicals. In the nine months ended December 2011, its nine per cent growth in profit before interest and tax (PBIT) of the tea business was negated by a loss in the sugar business and a 25 per cent drop in chemicals’ PBIT. Thus, overall PBIT was flat at Rs 72 crore.