Robust growth - Tata Coffee: Buy

Focus on value-added products and improved blending mix should aid profitability

The stock of Tata Coffee is up 37 per cent over the past year, thanks in part to the healthy global demand for coffee products. The parent company, Tata Global Beverages, in its partnership operation in India with global coffee chain Starbucks sources coffee beans from Tata Coffee.

At ₹125, Tata Coffee trades at about 20 times its trailing 12 month earnings. This is higher than its three year average of 18 times. Despite the somewhat higher valuation, investors with a two to three-year outlook can buy the stock.

In line with its long-term strategy, Tata Coffee is increasinglyearning better margins from higher value-added products through product differentiation and improved blending mix. Also, the company’s ability to meet Starbucks’ international quality standards is an indication of its competitiveness. These factors, along with robust demand for coffee products, should help the company’s growth.

Tata Coffee’s activities spanthe coffee value chain — from growing, curing to manufacturing and distributing value-added coffee products. Also, sale of tea, pepper and cardamom contributes a small share of the company’s revenue. Overseas operations account for the chunk of the consolidated revenue. About 60 per cent of the revenue in 2015-16 came from the US, 10 per cent from Russia and neighbouring countries, Africa and Europe, 15 per cent from India and the rest from other countries.

Coffee prices

The price movements of Robusta and Arabica coffee varieties, both of which the company grows, play a big role in its profitability.

Tata Coffee produced nearly 8,000 tonnes of coffee beans in 2015-16. Almost a fourth of this is Arabica, the higher quality beans, and the rest is Robusta.

The price of Arabica variety, after rising for much of the last year, has moderated in recent months. While the price drop affects realisations on seeds sold directly, it also cuts costs for the raw material in eight O’clock coffee — Tata Coffee’s US subsidiary. This should help improve margins, given that the subsidiary accounts for more than half the company’s consolidated revenue.

Tata Coffee’s production of the Robusta variety, which is predominantly used by the company for preparation of instant coffee, dropped around 11 per cent in 2015-16 compared to the year earlier. This year too, output is expected to be weak due to poor monsoon in peninsular India. Consequently, Robusta price has increased sharply over the past year. But demand for instant coffee, which uses the Robusta variety, continues to grow steadily, allowing Tata Coffee to navigate the price fluctuations comfortably. Healthy growth prospects for instant coffee should continue to aid the company.

Operational improvement

The company is increasingly improving operational efficiency through supply-chain improvements and plant de-bottlenecking.

Higher disposable income, rapid urbanisation and increasing acceptance of coffee (especially in emerging markets like South-East Asia and Africa) should help the company find a market for its wares.

The green field expansion in Vietnam, expected to be operational over the next 18 to 24 months, should produce an additional 5,000 tonnes of coffee. On the domestic front, with close to 90 Starbucks stores in operation, the company continues to gain good ground for its products.

Tata Coffee’s consolidated sales and net profit grew at annual average of 2.6 and 23.5 per cent respectively between FY-2014 and FY-2016.

Revenue for the nine months ending December 2016 grew by 4.5 per cent y-o-y to ₹1,211 crore. Thanks to improved operating efficiency, operating profit in this period grew about 45 per cent to ₹242 crore. The net profit at ₹105 crore for nine months ending December 2016 rose 53 per cent compared with the same period a year earlier. The management indicated good sales volume growth for the nine months ending December 2016. Also, improvement in cost management helped increase margins and profits.

The debt-to-equity ratio at the end of September 2016 was 0.78 times, compared with at 0.83 times as of March 2016 and about 1 time as on March 2015.

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