Rising prices, inorganic growth to boost McLeod Russel's prospects

Realisations expected to improve by eight per cent in FY13 and seven per cent in FY14

Falling global tea production and increased consumption would benefit McLeod Russel (McLeod) significantly. The McLeod management expects tea production in India would be lower by three-four per cent in 2012, consequent to which tea prices are expected to rise by about 15 per cent to Rs 25 a kg. Globally, too, against a flattish production growth of 0.5-0.6 per cent, tea consumption is expected to rise by two per cent, annually.

All these factors are likely to boost tea prices and hence the realisations and profitability of McLeod and other tea producers. These favourable macro dynamics will benefit McLeod the most, as it is the world’s largest producer of black tea, and hence, in a sweet spot. Add to this the undemanding valuations of 7.7 times FY14 estimated earnings and it makes most brokerages bullish on the stock. Notably, McLeod’s scrip has traded at a five-year average one-year forward price/earnings multiple of nine times.

 

“The McLeod Russel stock currently trades at 5.7 times FY14 estimated earnings, excluding treasury shares, which we believe is very compelling in the context of FY13-15 estimated earnings growth of 24 per cent, FY14-15 estimated average adjusted return on equity of 28 per cent and free cashflow Rs 31 a share in FY14,” believes Ankur Agarwal of Nomura Equity Research.
 

STRONG PROFITABILITY (Rs cr)
	FY13E	FY14E
Revenues (Rs cr)	1,621	1,852
% chg y-o-y	12.2	14.2
Ebitda margin (%)	26.9	29.8
Bps chg y-o-y	-	290
% chg y-o-y	10.0	22.9
EPS (Rs)	27.3	35.9
RoE (%)	17.0	21.2
Net profit	317	389
E: Estimated;                                     Source: Analyst reports

The stock, which has gained 7.7 per cent in November this year, was up 1.5 per cent to Rs 325.8 on Thursday. According to Bloomberg data, the consensus 12-month target price is Rs 366, while Nomura’s analyst has a target price of Rs 429.

Although adverse weather conditions in Assam will partly impact the company’s domestic tea production and earnings this financial year, on a net basis, it would still stand to gain. McLeod’s earlier moves to acquire tea gardens in Africa and Vietnam will boost its production significantly. Analysts expect McLeod’s realisations to improve by eight per cent in FY13 and seven per cent in FY14. Thus, McLeod’s Ebitda margins are expected to expand by 290 basis points in FY14. While profit growth is seen at about 10 per cent in FY13, the same is expected to be much better in the next financial year. “We believe there is a potential upside to the return ratios if McLeod decides to re-leverage its balance sheet by acquiring limited land/tea gardens, especially in Africa,” believes Agarwal of Nomura.

Given its strong market position, McLeod also stands to gain significantly from adverse weather conditions in Kenya and Sri Lanka in the form of higher exports at higher tea prices. On the flip side, given it exports 30 per cent of its domestic production and has exposure to foreign markets, any unforeseen volatility in exchange rates will reflect on its profitability. Broadly, analysts remain positive on the stock, even from a longer-term perspective.

“We are positive on the stock with domestic tea consumption growth outstripping production growth in the next four-five years. This will have a positive impact on tea pricing. McLeod is the largest company in tea production with a clean balance sheet and a huge operating leverage. We believe the downside in the stock is very limited,” said analysts at Motilal Oswal Securities in a recent report.