Buy Tata Consumer Products Ltd For Target Rs.680
Gross margin pressure likely to ease in coming quarters
Tea prices in North India increased (45% YoY) to INR229/kg over Apr-Dec’20 (v/s INR158/kg during the same period last year). However, prices have cooled off by 40% from the peak of INR284/kg in Aug’20 to INR171/kg in Jan’21. In this note, we have analyzed the impact of the fall in tea prices on Tata Consumer Products (TCP) in the near term. Here are the key insights:
Tea production has started to normalize…
* Production of North India tea (Assam and West Bengal), which accounts for 84% of the country’s tea production, was impacted due to the COVID-led lockdown and floods.
* Indian Assam tea is usually harvested in three flushes:
* The first flush is from mid-March to late-June (forms 32% of the whole tea cycle volumes and is of the best quality),
* The second flush is from July to September (forms 38% of volumes and is the second best in terms of quality), and
* The third flush is from October to December (forms 28% of volumes and is of inferior quality v/s the first and second flush) (as per 2019 production data).
* All India tea production (from Mar-Aug’20) is lower by 154m kg v/s last year due to: a) first flush of the crop being lost as plucking activity came to a standstill due to COVID-induced lockdown, and b) unfavorable weather conditions. In CY20, tea production in India declined 10% (to 1,256m kg), which created a supply crunch, leading to an increase in prices.
* However, production has started to normalize from Sept’20. In Sept’20, tea production grew 1% YoY, but declined by 1% in Oct’20. In Nov/Dec’20, tea production increased by 7%/11% YoY. All of which led to a decline in tea prices from its peak in Aug’20.
… and so have prices
* Shortage in supply led to an increase in North India tea prices by 61% YoY over Apr-Sep’20 to INR261/kg. According to the Tea Board of India, all India tea prices have increased by 50% YoY over Apr-Sep’20 to INR224/kg.
* With an increase in production, North India tea prices have declined 40% from the peak of INR284/kg in Aug’20 (Sept’20 price of INR268/kg) to INR171/kg in Jan’21. Tea prices over Apr-Dec’20 in North India has risen 45% YoY to INR229/kg.
* Our channel checks suggest that packaged tea prices of Tata Consumer (for select brands) as compared to pre-COVID levels were above 25% in OctNov’20, but declined 4% in Jan’21 from Oct-Nov’20 levels.
Gross margin pressure to decline in coming quarters
* Standalone gross margin fell 840bp to 30% in 3QFY21, leading to a 410bp contraction in EBITDA margin to 10% due to high tea prices.
* With price hikes taken by the company and sales from a portion of its low-cost inventory, which it procured in 3QFY21 (tea prices declined from its peak in Aug’20), gross margin pressure in 4Q is likely to ease, provided there is no significant price cut due to competitive intensity.
* The inventory, which will be sold in 1QFY22, would be the one that was procured in 3QFY21. Even after assuming a slightly moderate price increase, it won’t materially dent gross margin.
* We expect gross margin pressure to ease out from 4QFY21 onwards. However, the same will still be lower in 4QFY21 v/s 4QFY20, but will improve QoQ. Gross margin in 1QFY22 is expected to be normalized.
Valuation and view
* Performance during 3QFY21 was impacted due to higher tea prices, which led to 570bp contraction in consolidated gross margin. The management expects tea prices to stabilize by 1QFY22. This would ease the pressure on gross margin going forward.
* We expect gross margin to improve sequentially in 4QFY21 and normalize in 1QFY22.
* TCP has two strong legs in the India business - Tata Tea and Tata Salt - by which it is targeting lower double-digit growth, driven by cross-selling between Tata Chemicals and TCP's distribution channels, and expansion into new geographies.
* It is building its third leg - Tata Sampann, which should grow in high doubledigits and deals in pulses and spices. The market size of pulses/spices in India currently stands at INR1,500b/INR600b, with unorganized players constituting 99%/70% of the market. Growth is expected by grabbing market share from unorganized players by increasing the distribution reach. Apart from the above, TCP has launched nutrimixes (chilla), poha, and chutney in the ready-to cook space, which should aid growth.
* Over FY20-23E, we expect sales/EBITDA/PAT of 12%/20%/25% CAGR.
* We arrive at an FY23E SoTP-based TP of INR680/share. Maintain Buy.
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