Motilal Oswal : Maitains Neutral on Tata Tea

(BSE: 500800 | NSE: TATATEA | ISIN: INE192A01017)

Tata Tea’s 2QFY08 adjusted PAT at Rs702m is higher than our estimate of Rs530m. Adjusted EBITDA is Rs1.82b (est.Rs1.85b). Higher PAT is due to reduction of interest cost by GBP2m post renegotiation of interest rates.

Reported PAT at Rs1.09 is significantly higher than our estimate of Rs530m due to higher profit from associates (Rs183m due to land sale in Rallis India) and Rs240m profit from plantations, as the court approval of the de-merger scheme is still awaited.

Domestic branded tea volumes grew 15% as key brands like Tata Tea Premium, Tata Tea Gold and Agni enabled the company to maintain volume leadership. Tetley reported 2% sales growth for 2QFY08 to Rs5.53b. Operating profit for the quarter stood at Rs486m (Rs326m in 1QFY08) due to phasing out of advertisement expense and lower operational cost. PAT was Rs262m in comparison to Rs187.5m despite currency translation loss of 5%.

Tata Tea GB completed the sale of its stake in Glaceau for a profit of $415m. We estimate interest burden will decline to Rs1.1b in FY09 while income from surplus funds will increase to Rs1.9b.

Low growth Tetley and Eight ‘o Clock coffee comprise more than 72% of sales while high growth domestic market accounts for just 20% of the total sales. Moreover, Mount Everest Mineral water will contributing only after a couple of years. We are increasing our FY08 and FY09 EPS estimate from Rs44.9 and Rs78.7 to Rs48.7 and Rs81.3. The stock trades at 8.6x FY09E earnings (based on core earnings of Rs66 per share in FY09, excluding cash per share of Rs250). Although the stock offers value, lack of growth and any fresh triggers limit major upside. Maintain Neutral.

Lower interest burden boosts profits Tata Tea’s consolidated sales grew 12.6 % to Rs10.9b for 2QFY08. Strong volume growth in the domestic market and impact of Eight o’ Clock coffee acquisition boosted the sales growth. EBIDTA margin expanded 30bp to 18.8%, due to margin expansion in Tetley. Interest burden zoomed to Rs659m, which includes Rs364m interest on Glaceau acquisition. Adjusted PAT declined 39% to Rs702m (excluding exceptional income of Rallis and profit from North India Plantations). On a continuing business basis, adj PAT increased 2.7%.

Domestic branded business reports 15% volume growth Domestic sales reported 16.4% growth for 2QFY08 to Rs3.2b while EBIDTA increased 6.7%. Domestic branded business reported volume and value growth of 15% and 18% respectively. PBT from operations declined 8.7% as interest on loans for acquisitions (Rs130.9m) impacted theprofits. Standalone operations reported 19% decline in adjusted PAT from continuing businesses. This excludes Rs240m profit generated from the plantations business, which is in the process of being de-merged.

Tata Tea maintained volume leadership in the domestic tea market with market share of 20.3% in September; ahead of HUL by 60bp. Agni emerged as the fastest growing tea brand while Tata Tea Premium became the largest tea brand in India. Tata Tea is launching new value added products in Tata Tea Gold to boost volumes. The company has also launched single garden Darjeeling teas which would help accelerate the value growth for the company. Specialty teas launched by Tata Tea are likely to emerge as a meaningful category in another 2-3 years only. Global tea prices continue to be soft due to bumper crop in Kenya. We expect the company to maintain double digit volume growth in domestic branded business

Tetley – sales promotion impacts margins Tetley reported 2% topline growth at Rs5.5b for 2QFY08 while the PBT before Glaceau acquisition impact increased by 39% to Rs262m. The company reported strong market share gains across regions as the benefits of advertising campaign done in the last quarter was realized fully. Benefits of price increase in last quarter, favorable phasing of expenses and lower operational costs boosted margins. Lower tea prices globally also helped in boosting the margins.Integration of various acquired companies in on track. Jemca is beginning to settle down while Good Earth performance is stable. Joekels has provided a sound footprint for an entry into the South African market. Future growth potential is linked to increased geographical presence, specialty and herbal tea space and RTD segment.
We expect Tetley to undertake more such acquisitions in the specialty and herbal tea space and new geographies in the coming years, which can boost the long term sales growth.

Eight O’ Clock boosts Tata Coffee’s topline Eight’ O Clock reported a topline of Rs1.6b in 2QFY08 while EBIDTA was Rs351m. The company achieved a PAT of 97.4m. Higher topline growth was on account of sales of full three months in the current period. The company achieved low single digit volume growth during the period. Tata Coffee reported 12% increase in sales and 28% decline in EBIDTA due to impact of rupee appreciation and high raw coffee prices. Tata Coffee is experiencing some teething troubles with the recently commissioned freeze dried unit. Stabilization of new facility will be the key factor in improving the performance in the coming quarters.

Mount Everest Mineral Water – will pay only in long term Tata Tea is likely to complete acquisition of 46% stake in Mount Everest mineral waters as the open offer is currently on. The dispute regarding non-compete fee being a part of open offer price is pending with SEBI. Mount Everest has one of the best water quality aquifers on a 99 year lease from the government. Hence the long term revenue and profit potential looks immense. The Rs11b bottled water industry (including packaged water and natural mineral water) in India is growing at 25% per anum and is highly fragmented with 200 brands with a wide spectrum of price value offerings. Tata Tea plans exploit the water quality and brand equity in the Indian as well as the international markets. We believe that creating a viable distribution network and launching new products will take time; the venture is unlikely to contribute meaningfully in the coming 1-2 years.

Glaceau stake sale transaction completed; debt to come downTata Tea GB has completed the transaction for sale of its stake in Glaceau for a profit of $415m. Management doesn’t expect any tax liability on the transaction. We expect the company to use the proceeds for partial repayment of debt. We expect Tata Tea to close the current year with cash and cash equivalents of Rs21b and debt of Rs16b. We estimate that interest burden will decline to Rs1.1b in FY09 while income from surplus funds will increase to Rs1.9b.

Outlook Tetley and Eight ‘o Clock coffee comprise more than 72% of sales with sustainable growth potential of sub 5% only due to product segments and heightened competition in mature markets. Although domestic market volumes for Tata Tea are growing in double digits, it accounts for just 20% of the total sales. Moreover, we expect Mount Everest Mineral water to start contributing only after a couple of years. Tetley’s performance depends upon the ability of the management to increase the sales proportion of specialty tea (9% currently) segment, which has potential to grow at 15-20%. We are increasing FY08 and FY09 EPS estimates from Rs44.9 and Rs78.7 to Rs48.7 and Rs81.3. The stock trades at 8.6x FY09E earnings (based on core earnings of Rs66 per share in FY09, excluding cash per share of Rs250). Although the stock offers value, lack of growth and any fresh triggers limit major upside. Maintain Neutral.

Tata Tea: an investment profile Key investment arguments Tata Tea will make substantial capital gains on the sake sale of Glaceau which will be used to repay its debt and make strategic acquisitions. – Hiving off the north Indian plantation will result in cost savings and improved margins in the domestic businesses.

Key investment risks Tetley accounts for 2/3 rd of Tata Tea’s consolidated sales and is mainly present in the Black Tea segment which has been showing flat growth for some time. – Tetley’s consolidation with Tata Tea has given it a global presence and therefore adverse currency movements would negatively impact Tata Tea.

Recent developments The group has sold its stake in Glaceau for US$1.2b at a profit of 415 million dollar. – Acquired 46% stake in Mount Everest Mineral water company for Rs1.96b – Entered into a JV in China for the manufacture polephenols from low grade green teas.

Valuation and view We have an EPS forecasts of Rs48.7 for FY08E and Rs81.3 for FY09E. – The stock is trading at 16.7x FY08E EPS and 10x FY09E EPS. We maintain Neutral.

Sector view We have a cautious view on the sector on back of inflationary tendency in the economy which is might to impact volumes as well as profit margins of companies. – Companies with low competitive pressures and broad product portfolios will be able to better with stand any slowdown in a particular segment. – Longer term prospects remain bright, given rising incomes and low penetration.

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