>MCLEOD RUSSEL INDIA LIMITED (MERRILL LYNCH)

Tea Party; Raise EPS and PO

■ Reiterate Buy; raised PO to INR200; 43% upside potential
Post a strong quarter and sustainable surge in tea prices we increase PO to INR200 backed by 38% and 40% upgrade in FY10E and FY11E EPS. We estimate 13% increase in realized tea prices in FY10 which we believe will sustain through FY11. PO is pegged at 11xFY11 PE- in line with target PE of Buy rated India sugar stocks. Our new price objective offers 43% upside potential.

■ Tea prices at an all time high since yr 2000; upward bias
Production in Kenya & Sri Lanka (40% of global exports) declined 14% & 37% till April due to poor weather. Indian production is down 15% during this period. This will aggravate already existing pipeline deficit in India even if crop is normal in the rest of CY09. We expect Indian tea prices to remain firm around INR130/kg- an all time high since 2000 with an upward bias led by i) ~20mn kg est fall in India’s tea production in CY09 in addition to 23mn kg shortage and ii) strong global demand.

■ Robust Q1; Price leverage remains strong
Q1 EBIT was up 90% led by over 30% higher realizations. 1% increase in tea prices raises McLeod’s EPS by ~3.5%. We forecast 146% EPS growth in FY10 and expect EBITDA/kg to increase to INR38.5/kg from INR24.4/kg in FY09.

■ Attractive valuation vs peers
The stock trades at 7.5xFY11e PE vs Indian sugar co’s at 8x to 15x. It trades at the lower end of the range 6-27x FY11ePE for peers in global food commodities space. Adjusting for treasury shares, stock is at 5.5xFY11e PE. Valuation is attractive, in our view, given an upbeat tea price outlook. We believe risk of govt. intervention is low as tea forms just 1% of WPI basket and govt is in fact focusing on encouraging investments in tea gardens. Key risks: drastic cut in production in case of poor monsoon, lower than expected tea prices, wages and rupee appreciation.

To see full report: MCLEOD RUSSEL INDIA LIMITED