Indian Tea industry-The hot sip

Tea – The hot sip!What is driving the current rally in tea stocks?According to the Tea Board of Kenya (the second largest tea producing country in the world), tea production is expected to decrease by 10% yoy to 335mn kg compared to 2007 while export volumes are likely to drop by 25mn kg this year, due to dry weather conditions currently being experienced in tea growing areas and interruptions in tea plucking and processing owing to skirmishes experienced in January 2008.

As per the latest finding by the Food and Agriculture Organisation (FAO) of the UNO, the shortfall in Kenya could worsen an already tight global supply of tea and would further push up the prices. India accounts for 51% of the world’s tea production, while Kenya and Sri Lanka account for 20% and 16% respectively. Although, India is the largest producer of tea, it is also the largest consumer of tea and therefore only 15-20% of its produce is exported, while the rest is domestically consumed. Kenya on the other hand exports almost its entire produce and therefore a shortfall in Kenyan output would lead to tight global supplies.

During Jan-Nov’07, Kenya’s tea export volumes rose by 9.4% yoy from 288mn kg to 315mn kg. Following are the officially available world tea statistics up to December 2007. Estimates indicate that India, Kenya and Sri Lanka produced 945mn kg (Exports – 157mn kg), 370mn kg (Exports – 315mn kg) and 303mn kg (Exports – 269mn kg) of tea respectively. World tea production (mn kg)CountryShare in global production (%)Jan to20072006Inc/Dec (mn kg)yoy (%)India50.7Dec944.7955.9-11.2(1.2)- North India38.9724.7729.6-4.9(0.7)- South India11.8219.9226.3-6.4(2.8)Bangladesh3.1Dec5853.44.68.5Kenya19.8Dec369.6310.659.019.0Indonesia (PTP only)4.5Dec83.271.411.816.6Malawi2.6Dec48.145.23.06.6Sri Lanka16.3Dec303.2310.8-7.6(2.5)Tanzania1.8Dec33.630.33.310.9Uganda0.6Apr10.69.71.010.0Zimbabwe0.7Oct12.713.1-0.4(2.9)Total1001,863.71,800.363.43.5

Source: Indian Tea AssociationGlobal tea prices to firm upTea prices across all major tea auction centers of the world have remained firm for a large part of 2007. Colombo (Sri Lanka) average auction prices have remained firm at Rs103 per kg, while Mombasa (Kenya) auction prices remained flat Rs65 per kg. A smart rally has been witnessed post September at the Mombasa (Kenya) auctions, as fears of lower global production in the world’s largest exporting nation come true.

Indian tea production, has also declined by 1.2% yoy during Jan-Dec’07, which will lead to further rise in tea prices across all global tea markets. Tea industry veterans have been predicting that prices could rise by Rs5-7 per kg for the next full year and after taking Kenya into account, the rise is likely to be even higher. Trend in tea prices45.055.065.075.085.095.0105.0115.0125.0Jan-07Feb-07Mar-07Apr-07May-07Jun-07Jul-07Aug-07Sep-07Oct-07Nov-07Dec-07Jan-08(Rs per kg)World AverageColomboKolkataMombassaSource: World Bank, Note: International prices have been converted at an exchange rate of Rs40.1February 28, 2008
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2Tea – The hot sip!What does the Kenya shortfall mean for Indian tea industry?India contributes almost 13% to the total world tea exports. While the Kenya shortfall may open up a huge export opportunity, India may not be the largest beneficiary of this for two reasons:Sri Lanka – with better quality of teas, may capture a large part of this export opportunity. Indian tea producers, historically, tend to lose focus on quality to take advantage of rising prices by boosting production irrespective of quality deterioration.

Therefore, except for tea from a few premium locations, Indian tea is today considered inferior than Sri Lankan tea. Infact, India’s tea exports during Jan-Dec’07 have declined sharply by 28.4% yoy compared to mere 1.2% yoy decline in production. Exports (mn kg)Jan-Dec'07 Jan-Dec'06yoy (%)North India84.198.8(14.9)South India72.7119.9(39.4)All India exports156.8218.7(28.3)Total world exports1,190.81,259.5(5.5)Source: Indian Tea AssociationAs per indications from industry, India’s tea production is likely to remain stagnant in the current year depending on the weather conditions.

This could lead to further increase in tea prices.Therefore, the gains for Indian tea producers may not necessarily come from higher exports, but would come largely from higher realizations, as rising global prices would push up domestic realizations too.Who benefits the most?Large plantations, especially with a presence in North India, where quality of tea produced is better, would gain the most. Some of the leading north Indian tea plantation companies are Mcleod Russel, Duncan’s Industries, Jay Shree Tea and Goodricke Tea. Mcleod Russel with 55 tea estates (31,953 hectares, + four tea estates of recently acquired Moran Tea Company (India) Ltd) and 48 tea processing factories across north-eastern states of India has emerged as the largest plantation company in India with a capacity of 78mn kg and accounts for 75%+ of Assam tea exports. In the southern region, Harrisons Malayalam is the largest tea plantation company. Indian tea export realizations CountryJan-Dec'07Jan-Dec'06mn kgRs/Kgmn kgRs/KgTotal Exports156.897.5218.791.7North India84.1113.198.8120.6South India72.779.3119.968.0

Source: Indian Tea AssociationBranded tea players may face some margin pressureFirm tea prices, will be a concern for the branded tea players, since it will lead to an increase in their tea procurement cost. The two large branded players - Tata Tea and HUL have divested some of their plantations over the last 2-3 years. Therefore, the natural hedge that they had in the past is reduced to that extent. If tea prices continue to rise, these companies may face margin pressure, unless they are able to push the higher costs on to the consumers.

In the past, Tata Tea with significant part of revenues coming from plantations was among the most profitable play on tea price increases. However, post acquisition of Tetley and divestment of plantations, almost 90%+ of Tata Tea’s consolidated revenues come from the branded segment, with plantations accounting for less than 10% of revenues. Although we are positive on the outlook of Tata Tea’s business, it may not be the best play to capitalize on the rising tea price trend. Some of the large plantation stocks like Mcleod Russel, Duncans Industries, Goodricke, Jay Shree and HarrisonsMalayalam may offer greater appreciation.
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