Unfavorable weather leads to lower production globally
We believe that the heavy rains in Assam in September which produced
more than half (~51%) of India’s tea production in 2011 (according to
Tea Board of India) have caused production losses of (Hindu Business
Line, 2nd October) of another 18-20mn kg in the September month on
top of the 12mn kg lost between January –July 2012. This will mean that
India’s total production loss in CY2012 which till July was ~20.8mn may
be in the range of 28mn kg-40mn kg (August production was apparently
higher versus 2011, and if some make-up happens in Nov-Dec versus
last year when there were some crop losses last year). A similar trend
persists across other major countries including Kenya and Sri Lanka. In
Sri Lanka crop losses have intensified owing to the worst draught the
country has faced since 1992 and the output of high grown teas is down
11.6% during January to August this year from a year ago, while the
Kenyan tea board is guiding to a 5% decline in production for the full
year.
Tea prices remain firm, but expect another uptick as opening
inventory for next year is expected to be low
Expected crop loss of ~ 28-40mn Kg in CY12 vs CY11 and annual
increase in domestic consumption by 3% in India would result in another
spike in tea price in FY14. This is clear from the fact that monthly tea
price differential versus last year is firm at an average of INR23/kg in
Sep’12 unlike last year when the differential was negative. The average
tea price for North Indian tea in April’12- Sep’12 was INR151/kg, ~18.3%
higher than last year’s INR127/kg. As we approach the winter season
when tea production drops and consumption increases, we believe that
shortage of tea will become more evident and will lead to an increase in
tea prices unlike CY10 and CY11 when tea prices came down.
As mentioned above, adverse weather conditions in India, Kenya and Sri
Lanka (the top three black tea producing nations, which according to
“Tea Statistics” by J Thomas and Company account for 65% of global
production) has impacted global production of black tea. This would
result in global production of tea to drop by ~ 60 mn Kg (we were
expecting ~50mn kg earlier) in CY12, which should also drive
international tea price in FY14, in our view.
2Q preview, 8% growth in EBITDA and ~15% in PAT, could have
been higher if it was not for the crop loss in September
We expect an ~INR22/kg increase in realizations even though
production and sales will be impacted by an additional crop loss of
3.7mn kg in Q2 which will be only partly offset by 1.4mn kg of additional
bought leaves versus Q2 of last year. Overall we are building in an 8%
increase in EBITDA and a ~15% increase at the net profit level for 2Q.
World’s largest listed tea player; acquisitions likely to drive further
growth
MCLR is the world’s largest producer of black tea (~4% of global black
tea production) with a presence in India, Vietnam, Uganda and Rwanda,
according to management. Given its existing scale and balance sheet,
which we believe will place MCLR in a net cash position (excluding any
acquisition in FY13), the company appears to be well positioned to
consolidate its position further by acquiring quality land globally to drive
growth. MCLR’s geographical diversification is a natural hedge against
the vagaries of the weather, in our view. The scale of MCLR’s forays
outside of India are something that some of India’s smaller tea players
are looking to emulate now when the price of these assets has increased
in the market’s expectation of a tea upcycle.
Limited land supply, increasing weather uncertainty and steady
demand likely to result in an upward bias in tea prices
Limited land availability in regions that are conducive to growing black
tea and steady growth in demand mean that the delta between supply
and demand is shrinking progressively. Over the next five years, we
expect global black tea production to remain stagnant with 0.5-0.6%
annual growth, whereas we expect consumption to rise by 2% annually.
In addition, the low probability of optimum weather across all producing
areas in any given year leads to supply fluctuations and results in an
upward bias in prices.
Reiterate our Buy rating
The stock currently trades at 8.2x FY14F EPS. We continue to value
MCLR at one-year forward P/E of 10x FY14F EPS of ~INR39.4, a
multiple we think is fair based on our estimate of FY12-14F EPS CAGR
of ~21%, FY14F ROE of 20% and FCF of ~INR32.6/share (~10% FCF
yield).
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