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Tata Tea: Slow and steady

Jun 8, 2006

Performance summary
Tata Tea, the world’s second largest branded tea company, declared enthusing results for FY06. While the topline, at the consolidated level, grew by 2% YoY, the extraordinary effect has boosted the bottomline (up 39% YoY). However, if one were to exclude the extraordinary item, the actual growth in bottomline stands at 13% YoY, which is commendable. What is important to note is the consolidated operating margins improved by 40 basis points.

Consolidated Financial Performance
(Rs m) FY05 FY06 Change
Income from Operations 30,591 31,239 2.1%
Expenditure 25,194 25,615 1.7%
Operating Profit (EBDITA) 5,397 5,625 4.2%
Operating Profit Margin (%) 17.6% 18.0%  
Other Income 174 269.4 54.8%
Interest (Net) 1,228 1,024 -16.6%
Depreciation 779 758 -2.6%
Profit before Tax 3,565 4,111 15.3%
Extraordinary income/(expense) (428) 73  
Tax 939 1,179 25.6%
Profit after Tax/(Loss) 2,199 3,005 36.7%
Minority Interest (44) (14) -68.4%
Net profit 2,155 2,992 38.8%
Net profit margin (%) 7.0% 9.6%  
No. of Shares (m) 56.2 56.2  
Earnings per share (Rs)   53.2  
P/E (x)   12.4  

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 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 plantation’s 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 Tata’s hold 18% stake in the new company and will continue to support its marketing and R&D needs.

What has driven performance in FY06?
International operations firming up: Tata Tea’s consolidated topline growth was largely aided by higher contribution from branded tea sales (88% of the total sales). During FY06, The Tetley group (Tata Tea’s 98.6% subsidiary) clocked a near 13% and 83% YoY growth in topline and bottomline respectively. Topline growth was mainly due product innovation and volume thrust. The growth in bottomline was largely due to lower interest and depreciation costs. Even in a rising interest rate scenario globally, the company was able to raise debt at lower rates (164 m pounds). The interest rate paid during the year was 6%. Higher other income was another positive. The growth was further aided by the profit on the sale of the tea plantations business. Apart from that, its joint ventures (JVs) in Bangladesh and Pakistan also posted improved performance. In volume terms, Pakistan has now become the 5th largest market for the group. The Bangladesh JV has given the group a 5% market share in the country.

Income during the year went up in UK (2%), US and Canada (21%) and Rest of the world (11%) largely due to increase in the demand for fruit, herbal and green tea as compared to black tea. Tata Tetley has gained a significant share in these regions as result of the same. This is a key positive for the company, as during FY04-05 in UK, US and Canada sales contracted.

Financial Performance: Indian Operations
(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Income from Operations 2,204 2,191 -0.6% 8,996 9,821 9.2%
Expenditure 2,146 2,079 -3.1% 7,563 8,063 6.6%
Operating Profit (EBDITA) 59 112 90.8% 1,434 1,758 22.6%
Operating Profit Margin (%) 2.7% 5.1%   15.9% 17.9%  
Other Income 290 245 -15.5% 504 580 15.0%
Interest (Net) 15 17 17.0% 85 90 5.9%
Depreciation 60 52 -13.6% 220 194 -11.6%
Profit before Tax 273 287 5.1% 1,633 2,054 25.7%
Extraordinary income/(expense) (12) (23) 94.1% (12) 252 -
Tax 3 71 2260.0% 332 436 31.2%
Profit after Tax/(Loss) 258 193 -25.2% 1,289 1,869 45.0%
Net profit margin (%) 11.7% 8.8%   14.3% 19.0%  
No. of Shares (m) 56.2 56.2   56.2 56.2  
Earnings per share (Rs)         33.3  
P/E (x)         19.8  

Bad quarter, good year: For Tata Tea’s domestic operations, 4QFY06 was a quarter to forget. The drop in topline during the quarter was on account of lower sales (as a result of the sale of plantations in South India). However, for the full year (FY06), higher brand realizations, higher volumes, lower blending costs and better crop produce in North India have been instrumental in the over 9% growth in the topline. The healthy growth of all its domestic brands - Tata Tea Gold, Gemini, Chakra Gold, Agni and KD Red saw them gaining significant market share in their respective regions. Apart from that, in the tea bag segment, Tata Tetley now has a 30% market share. There has been a 12% growth in the overall brands of the company during the year.

Strong overall picture: At the end of FY06, domestic operations contributed 31% to the topline and over 62% to the bottomline, although there have been many one-off incomes and expenditures during FY06, we believe that the Indian operation will continue to drive profitability in the medium term.

Cost Break-up (Domestic Operations)
(As a % of net sales 4QFY05 4QFY06 FY05 FY06
Material costs 35.4% 41.8% 22.0% 29.7%
Staff costs 25.9% 15.6% 28.2% 17.1%
Advertising & sales expenses 10.7% 11.1% 8.5% 9.2%
Other expenditure 25.3% 26.5% 25.3% 26.2%

Lower staff costs continue to help margin expansion: Operating margins for FY06 expanded by 200 basis points, largely due to lower staff costs, which was due to the further reduction in the number of employees. The company has been running an employee separation scheme since the start of the financial year. At the end of FY06, the number of employees stands at around 34,000, pruned from over 56,000 at the start of the year. The employee separation plan is likely to spill over in FY07.

Bottomline boost: Net profit during 4QFY06 fell by over 25%, largely due to the high tax outgo during the quarter under consideration (effective tax rate 25% in the current quarter as compared to 1% in 4QFY05). However, the strong bottomline performance for the full year was largely driven by exceptional items, like the profit on sale of the plantation business and the change in the accounting standard in UK. Higher other income has also been a key driver for the bottomline.

What to expect?
At the current price of Rs 660, the stock is trading at a price to earnings multiple of 12.4 times FY06 consolidated earnings. The company announced a 120% dividend for FY06 (1.8% dividend yield). The group, during the year, was able to introduce new variants, which acted as the catalyst for growth at the topline level. Apart from that, the softening of tea prices in Africa will benefit the company. The recent acquisition of Jemca in the Czech republic has opened the door for its entry into other European economies. Overall, while India will be the growth driver, the international operations will take more time to restructure and to that extent, the risk profile of the stock increases.

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