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Tata Tea: Acquisitions brewing up! - Views on News from Equitymaster

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Tata Tea: Acquisitions brewing up!
Feb 5, 2007

Performance summary
The world’s second largest branded tea company, Tata Tea, announced results for the third quarter and nine months ended December 2006. The company reported a 37% YoY growth in the topline (on a consolidated basis for the quarter led by higher branded tea sales coupled with inclusion of income pertaining to the acquisitions of Jemca and Eight O’ Clock Coffee. Despite strong revenue growth and operating margin expansion, the bottomline has declined by 42% YoY (excluding the extraordinary item) due to higher interest and tax expenses.

Consolidated Financial Performance
(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Income from Operations 8,117 11,126 37.1% 23,072 28,855 25.1%
Expenditure 6,701 9,120 36.1% 18,658 23,471 25.8%
Operating Profit (EBDITA) 1,416 2,005 41.6% 4,414 5,384 22.0%
Operating Profit Margin (%) 17.4% 18.0%   19.1% 18.7%  
Other Income 3 68 2009.4% 220 882 301.8%
Interest (Net) 283 909 221.3% 787 1,655 110.4%
Depreciation 187 262 40.4% 548 722 31.7%
Profit before Tax 950 901 -5.1% 3,298 3,889 17.9%
Extraordinary income/(expense) (123) 754 - 97 1,075 -
Tax 223 393 76.1% 933 983 5.4%
Profit after Tax/(Loss) 604 1,263 109.1% 2,462 3,981 61.7%
Share of profit/(loss) from assosiates 21 (9) -142.9% 97 88 -9.0%
Minority interest 24 82 239.0% 82 155 89.1%
Net profit 601 1,172 95.1% 2,477 3,913 58.0%
Net profit margin (%) 7.4% 11.3%   10.7% 13.8%  
No. of Shares (m) 56.2 59.0   56.2 59.0  
Earnings per share (Rs)*         75.0  
P/E (x)*         9.6  
* 12months trailing            

What is the company’s business?
Tata Tea is the largest integrated producer of tea in the world and has a market share of 21% in India (FY06). It has a total acreage of 24,500 hectares located in Kerala, Assam, Tamil Nadu and West Bengal and owns a majority stake in Tata Coffee, the largest coffee company in Asia. Tata Tea's profile changed the day it acquired Tetley of UK (FY01). From being a key player in a commodity industry (tea), it made an overnight transition to becoming the No. 2 player globally in the branded tea market. Tetley has 26% share of the UK, 43% of Canada, 11% in the US and 19% of the Australian tea market. The company is looking to expand into Asia Pacific and the Middle East.

Tata Tea hived off its plantations business in South India, which led to it emerging as a focused branded tea company. It transferred 16 estates in Munnar (Kerala) to a company, which is owned by the plantation workers (each worker got a stake in the new company with a minimal investment of Rs 3,000). The Tatas hold 18% stake in the new company and will continue to support its marketing and R&D needs.

What has driven performance in 3QFY07?
Domestic story: The domestic revenues (up 4.4% YoY) were mainly driven by brand value sales, which have grown by 16% YoY. The bottomline growth considerably outpaced revenue growth mainly aided by higher other income, lower depreciation charges and an extraordinary income. The extraordinary income was derived from the profit on sale of investments. However, even if we exclude the extraordinary income effect, bottomline has declined by 20% YoY for the quarter. The company has made an investment in its subsidiary, Tata Tea GB Ltd, UK to partially finance the acquisition of a 25% stake in Energy Brands Inc, USA (EBI). This investment in the subsidiary has been financed by bridge loans on which the interest amounts to Rs 124 m. As a result, the interest cost increased by 433% during 3QFY06, which along with higher tax outgo was the main culprit for the decline in profits.

Rs m 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Income from Operations 2,784 2,908 4.4% 7,701 8,191 6.4%
Expenditure 2,256 2,351 4.2% 6,055 6,364 5.1%
Operating Profit (EBDITA) 529 557 5.4% 1,646 1,827 11.0%
Operating Profit Margin (%) 19.0% 19.2%   21.4% 22.3%  
Other Income 33 80 143.1% 335 680 102.9%
Interest (Net) 28 151 432.9% 73 219 201.8%
Depreciation 44 46 4.6% 142 139 -2.5%
Profit before Tax 489 440 -10.1% 1,766 2,149 21.7%
Extraordinary income/(expense) 202 614   275 1,272 362.7%
Tax 79 112 41.8% 365 394 7.9%
Profit after Tax/(Loss) 613 942 53.7% 1,676 3,027 80.6%
Net profit margin (%) 22.0% 32.4%   21.8% 37.0%  

International sales led the growth: The consolidated sales were up 37% YoY in this quarter driven by branded tea sales and acquisitions done by the company last year. The international sales outperformed the Indian operations with a 54%YoY growth in the topline. The contribution to the total sales increased from 66% in 3QFY06 to 74% in 3QFY07. The new acquisitions namely Good Earth, Jemca and Eight o’ clock coffee too performed well. During the quarter, The Tetley Group (the company’s 77.78% UK subsidiary) reported a 13.7% YoY growth in revenues. Its contribution to the total sales has come down to 54% from 66% in the quarter.

Indian operations cost break-up
As a % of net sales 3QFY06 3QFY07 9mFY06 9mFY07
Total Cost of goods 33.0% 35.3% 26.1% 28.9%
Staff Cost 13.0% 12.4% 18.3% 16.0%
Advertisement 9.2% 8.9% 8.6% 8.3%
Other Expenditure 25.8% 24.3% 25.7% 24.5%

The margin picture: Inspite of higher raw material costs, the Indian operations’ margins expanded marginally during the quarter owing to lower staff and advertising expenditure. The operating profits of the international operations rose by 63% YoY with margin improvement of 100 basis points in the quarter, contributing to the 60 basis points operating margin expansion at the consolidated level.

Interest and extraordinary effect: Tata Tea’s consolidated net profits were up 95% YoY during the quarter led by extraordinary income to the tune of Rs 754 m (profits on sale of investments and forex gain) received by the company. Excluding this, the net profits declined by 42% YoY. Despite an increase in other income, it was the higher interest and tax expenses that dented the net profits. The interest on borrowings for acquisition includes payouts on account of purchase of Energy Brands Inc., Eight O’ Clock Coffee, Jemca & Good Earth, which is expected to continue even in the next quarter.

What to expect?
At the current price of Rs 719, the stock is trading at a price to earnings multiple of 9.6 times its 12-month trailing consolidated earnings. The acquisitions are expected to be key growth drivers for the company in its bid to become a major player in the beverage segment. Also, its restructuring efforts are paying off. However, the high interest costs and uncertainty of the tea cycle will be the key risks going forward.

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