>TATA TEA (KOTAK SECURITIES)

■ Confluence of positive factors. Our positive stance on Tata Tea (TT) is reinforced after a recent interaction with management and our channel checks at a Wal-mart store in US (on Eight O Clock coffee). Three factors aiding TT are (1) Tetley UK is operating at its highest EBITDA levels—a perfect cash cow, (2) good growth in EOC providing mix improvement and (3) input cost inflation and price increases (possible due to rational competition from Unilever) is likely helping TT post EBITDA growth. Reiterate BUY.

■ Tetley’s UK black tea business is a perfect cash cow
Tata Tea reported modest volumes (Tetley black tea volumes have likely declined) growth in
1HFY10. In a recent interaction, management indicated that Tetley’s UK operations are posting the highest-ever EBITDA at a percentage level—indicating that TT is utilizing the UK black tea business as a perfect cash cow to raise resources which can seed growth in other opportunistic areas and markets. The 100 bps volume market share loss (yoy to 28.7% in 2QFY10) in UK market seems to indicate this. We agree with this strategy; however, we note that successful identification of investible businesses is imperative for gainful deployment of resources raised from the UK black tea operations.

We believe the company’s strategy of focusing on new markets and new initiatives in tea (aggressive push of herbal and green tea) is paying off well. We believe the initial success of integration of various recent acquisitions is visible. Black tea accounts for about 70% of Tetley’s UK operations, while the rest is accounted by other value added tea including red tea, green tea etc. The management intends to reduce the contribution of black tea to 50% from the current 70% over the next three to four years.

■ Contrary to conventional wisdom, input cost inflation is a boon for TT
Higher tea prices combined with rational competition from Unilever globally and HUL in India are likely aiding TT in effecting judicious price increases to cover the inflation in tea commodity prices (EBITDA margins were maintained at ~12% for 1HFY10 even as TT effected a 16% price increase at consolidated level). We recall that at the analyst meet in June 2009, the management had indicated that it plans to focus on value sales and profitability in FY2010E, even at the cost of volumes. In FY2010-11E, we expect TT to post 10% and 15% EBITDA growth on the back of input-cost-inflation-led price increases.

To read the full report: TATA TEA