Mcleod Russel India - SPA Securities

We met the management of MRIL, the World's largest Tea company, to assess the current trends in Tea Industry and to comprehend the company's future growth strategy. MRIL enjoys strong bargaining power with the buyers, which has enabled the company to deliver consistent returns and report strong financials. With rising demand due to favorable demographic profile of India and rising consumption in rural areas, MRIL is looking to increase its capacity and buy more leaf from small growers. Given below are key takeaways from the visit:-

"Bought leaves" segment to drive volume growth in long term

MRIL is targeting to clock volumes of 89 mn kg in FY14 as against INR 78 mn kg in FY13. This will be led primarily by bought leaves segment, wherein it expects to sell 24 mn kg in FY14 (19 mn kg in FY13), Volumes from own production is expected to increase from 60 mn kg in FY13 to 65 mn kg in FY14. Long term volume growth will come from bought leaves segment as MRIL is targeting to increase its bought leaves capacity to 40 mn kg in next 3 years. MRIL enjoys EBIDTA/kg of ~INR 33 in this segment as against more than INR 40 earned through own manufacturing.

Volumes in overseas subsidiary to remain steady

MRIL expects volume to remain flat in Vietnam (at 6.2 mn kg) & Rwanda (at 2.3 mn kg) and grow by 12.2% in Uganda to 17.5 mn kg in FY14. Overall MRIL expects its subsidiaries to register a volume growth of 8.3% to 26 mn kg in FY14.

Looking for inorganic growth opportunities overseas

MRIL is scouting for acquisitions in the African region which are known for their high yields and low costs. It is more focused on assets in Rwanda due to better quality tea and higher realisations of ~$3.7/kg as against ~$2/kg earned in Vietnam and Uganda. Although it is not in talks with any player as on date, MRIL is comfortable to pay ~2x Sales/5x EBIDTA for the acquisition. Any acquisitions undertaken would allow the company to reap benefits of increased volume growth and better margins going ahead. The company is not keen on any acquisition in India due to higher valuations of ~INR 450/kg demanded by players.

Production to recover in FY14

Tea output in FY14 is expected to be better because of favourable weather conditions. Normal weather conditions in most leading black tea producing countries have led to better production in the first quarter and current conditions indicates a better year for overall global tea output. Production in India is expected to improve to 1115 mn kg in CY13 from 1111 mn kg in CY12.

Prices expected to stabilize

Despite higher production expected this year, MRIL expects overall prices to remain stable at last year levels due to significantly lower inventory in India and continued steady consumption growth of tea. Teas prices are currently ruling lower by ~INR 8/kg as compared to same period last year. MRIL expects this trend to reverse as we enter the quality period and expect overall prices to recoup to last year levels. It is expecting a INR 5/kg improvement in domestic realisations in FY14.

Outlook & Valuation

Expected increase in production coupled with steady tea prices provides encouraging outlook for the company. Increasing contribution from bought leaves segment will enable MRIL to earn fixed return and improve its cash flows. International operations provide stability to overall profitability. Margins are expected to improve due to improved production and marginal increase in cost/kg. Wage inflation is expected to be only 6% this year as against 15% last year. Shareholders would also benefit from increasing dividend payout as free cash flows remain strong. Earnings are expected to register a CAGR of 22% over FY13-15E. The stock is currently trading at a P/E of 7.5x its FY15E consensus EPS of INR 38.

Source : Equity Bulls

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