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  • Sep 18, 2009 - Tata Coffee: Profits constrained by commodity cycle

Tata Coffee: Profits constrained by commodity cycle

Sep 18, 2009

Tata Coffee is the largest integrated coffee company in the world. For FY09, its consolidated sales grew by 21% YoY while its operating profit as a percentage of sales fell by 2.4% to 14.4%. Its bottom-line fell by 12% YoY during FY09 due to increase in cost of raw material and selling expenses. Tata Coffee derives its revenue from primarily three streams

  1. Plantation sale of tea, coffee and spices, curing works (processing coffee beans)
  2. Sale and export of instant coffee and filter coffee
  3. Hospitality business (leasing out bungalows at coffee plantation sites)

Plantations:
The tea production at the company's plantation was 7.6 m kgs in FY09, an increase of 17% YoY while the production of coffee was 5,776 metric tonnes (mts) during the same period a drop of 28% YoY. The sharp drop in coffee production was on account of unseasonal rain on the blossom. The pepper crop recorded a growth of 110% YoY.

Curing Works
The company's curing works cured a total of 11,195 mts during the year as against 11,247 mts in the previous year. Also 365 mts of monsooned coffee was processed during the year as against 413 mts during the previous year. The drop in quantity was due to overall poor crop. In spite of this, the financial performance improved through cost reduction initiatives and better husk sale realization.

Exports
Coffee exports during the year fell by 8% YoY due to depressed economic conditions. Exports were 52% of sales in FY09 as against 50% in FY08. The main destination for the export was Italy.

Instant Coffee Division
Exports of instant coffee fell by 33% YoY during FY09. This was due to an overall slowdown in Russia and CIS countries which are the company's main markets. Though the company was able to notch up higher volumes in the first half, the third and fourth quarters, during which period normally higher sales take place, witnessed a severe downslide.

Coffee Value-Added Products
Although the packaged filter coffee market is shrinking the company improved its performance and held on to its market share in this category. This was due to the company's foray into supplies to hot teashop segment and robust demand from institutions.

Plantation Trails
The company's hospitality business performed well during the year as a result of increasing awareness and advertisement campaign undertaken.

Eight O' Clock Coffee Company (50.08% holding)
Eight O' Clock Coffee (EOC) turned a strong performance for FY09 with sales growing at 32% YoY while the bottom-line grew by 21% YoY. The company benefited during the year thanks to an article by a prominent US consumer magazine calling it "the best tasting and best value coffee available for retail in the US". EOC on the back of this recognition increased its shelf space and point of distribution including Wal-Mart which helped it gain market share.

Alliance Coffee Limited (51% holding)
In FY09, sales of Alliance Coffee Limited (ACL) increased by 13% while the bottom-line grew by 25% YoY.

Balance Sheet Analysis
The current ratio of the company stands at 1.3 times. Although this is the lowest in the last 3 years, the company is still comfortable with its short term liquidity. On the other hand debt to equity ratio has been rising and is the highest in the last 3 years at 2.7 times. While the company has an interest coverage ratio of 2.2 times, in our opinion it is highly leveraged. The return on equity is a dismal 6.3% while the return on capital employed (ROCE) is 9.6%, a drop of 2.2% YoY. The drop in ROCE is due to additional debt taken, the effects of which have yet to translate into higher operating profits.

What to expect?
At a price of Rs 363 the stock is trading at 35 times its trailing 12 months earnings. The company is in a difficult business where is it exposed to the vagary of the commodity cycle. Its recent acquisition, EOC has been performing well which has supported the company's performance. The only way for the company to grow is to market value added coffee and to increase its geographical presence. Moreover, we are not comfortable with the level of leverage on the company's books. We are following this company and believe it would be an interesting story as its starts drawing more and more of its revenue from branded sales.

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