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Tata Coffee: Is it about the best beans? - Outside View by Luke Verghese
 
 
Tata Coffee: Is it about the best beans?

It's Heritage

Tata Coffee is designated as the single largest integrated coffee plantation in Asia. Incorporated in Edinburg, Scotland, as Consolidated Coffee, it may have been the first MNC coffee plantation to offer its equity shares to the Indian public, way back in 1943. It may also have been the first sterling plantation company to completely exit from India in the 1950's, when it unloaded its entire foreign holding in the company.

The economics of plantation companies

Publicly held plantation companies in India don't have it that easy in cranking out profits each year for their many shareholders. (For this and several other reasons, plantation companies are also no longer fancied by the markets). The bigger problem is that they cannot easily expand by acquiring new lands and cultivating plantation crops, as large acreages are not easily available for this purpose. Besides, the cost of land acquisition could make it a prohibitive exercise. So, they have to resort to other means, so to speak. An increase in the level of productivity, both in terms of yield and a higher per capita output, on the one hand, and by creating value addition on the other. Another way out is to acquire different plantations, as a hedge against fluctuating commodity prices, and, as an antidote to the vagaries of the weather. Tata Coffee went one step further. It also acquired foreign companies in a flanking move and it has paid off handsomely. So much so that 'other income' including largely from dividends, accounted for 92% of pretax profit in FY10.

Whether ConsCof made do with any improvements in the labor productivity chain is not readily available, as the respective labor strength of none of its 4 divisions is known. (Irrespective of the productivity levels, labor costs are steadily going up. In FY10, payouts to employees clocked in at Rs 847 m, up from Rs 795 m in the preceding year). What is known however is the total land area, and the total quantum of production. The total coffee crop in FY10, at 9456 tonnes was the second highest in the last decade. But the crop in the preceding year at 5776 tonnes was the lowest in the decade! The area under cultivation at 18,300 acres is stagnant. Incidentally, it achieved its highest coffee production for the decade in FY03! So the question of measuring productivity of any kind does not arise here! The big change that happened however was in tea. It added substantially to its tea holdings in FY06. In FY06 it produced 2,669 tonnes and by FY10 production had increased steadily to 7,994 tonnes. That works out to a dramatic increase in the yield per acre, or some such.

The tea division

In FY06 Tata Coffee acquired the Anamallai Group Estates, and now has 6,100 acres of tea. In FY10, it was this tea division that came to its aid on the bottom-line front. This is quite evident from the figures available in the 'segment reporting' schedule. The segment profit from coffee sales fell from Rs 200 m to Rs 50 m while the segment profit from tea sales increased to Rs 149 m from Rs 79 m. The sales of these two commodities accounted for 93% of overall sales.

The investment in tea is turning out to be a money spinner of sorts. The profit margin on tea sales in FY10 rose sharply to 23% from 14% previously, while the margin on coffee sales dropped to 2% from 8% in the preceding year. Not included in this margin calculation is the rather sizeable 'unallocated net corporate income' of Rs 360 m (Rs 96 m previously). As a matter of fact the unallocated corporate income is appreciably more than the profit recorded by its 4 operating divisions together at Rs 216 m. This windfall represents 'other income' mainly dividends. The dividend income more than doubled to Rs 378 m during the year.

Adding value Over the years' the company has been making efforts at adding value. It has a manufacturing capacity to make instant coffee and, cured and roasted coffee, thus adding value to the end product. But the value this process adds, to the price that it realizes at the sales point, is not known. It has a capacity to make 5,000 tonnes of instant coffee. But instant coffee production dropped sharply to 2,954 tonnes from 5,219 tonnes, in the preceding year. Similarly, production of cured coffee is also down by 7% to 10,427 tonnes, as is roasted and ground coffee. Much of the produce one supposes is exported to the CIS countries, and such like. Probably a lack of demand put paid to its value added ambitions, at least for the time being. In any event, this sudden change in scenario is difficult to comprehend.

Not to be missed out is the traded sales. But what margins this business brings in is not known either. What is clear is that it bought traded items worth Rs 209 m. But there is no clue of how the company flogged what it purchased. Presumably it made some money in the bargain, or at least one hopes so.

The other income factor

The division that makes the most money is classified under 'Others.' This is by raking in margins of 70%, albeit on a laughable turnover of Rs 20 m. This could well be the hospitality division of the company. But every dime added to the bottom-line helps. Why the company shows this income generation as a separate division is the bigger question.

If the purchase of the tea company was a wise move, its acquisition of its 2 subsidiaries appears to be a master move of sorts. It has 2 subsidiaries and one JV, Tata Uganda. The company has invested Rs 1.4 bn in its wholly owned subsidiary Consolidated Coffee Inc. The latter in turn has invested in Eight O' Clock Coffee and Alliance Coffee. Both are money spinners alright. The dividend of Rs 378 m that it earned works out to a 27% return on its investment. As a matter of fact Eight O' Clock dwarfs the parent in turnover terms. The latter recorded a turnover of Rs 9.6 bn against a turnover of Rs 3.3 bn by the parent. Alliance Coffee, the commission agent, is top of the pops, with a pretax profit margin of 73%, albeit on a piggly wiggly turnover of Rs 45 m.

Its several investments have come at a price though. Borrowings at year end stood at Rs 1.5 bn, despite the company's efforts to pare debt. The company does not generate that much cash from operations and it has to plough some into fixed assets. Managing coffee plantations is a costly exercise. In this scenario, the company even saw value in plonking down some Rs 340 m as deposits in other companies, which earned the company nary a dime as interest. Who are the beneficiaries of this largesse please? Even more surprising is that the interest debited to P&L account works out to a mere 4.2% of the funds borrowed. This is remarkable funds management by any yardstick.

Book values hide the economics of plantation cos

The most interesting aspect of this company is that the turnover that it generates is barely equal to the value of its gross block. A gross block of Rs 3.3 bn generated a sales and service income of a like amount. However, one has to remember here that all the land is valued at a mere Rs 778 m in its books. If the current market value of the land is to be substituted for this price, the very economics of running this company would be totally lost!

Even though the management is trying hard enough, there is really very little to commend this company to an investor.

Disclosure: Please note that I am not a shareholder of this company

This column Cool Hand Luke is written by . Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.

Disclaimer:
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