TATA GLOBAL BEVERAGES - Right Horizons

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TATA GLOBAL BEVERAGES

FMCG INDIA RECOMMENDATION: HOLD | MBP: Rs. 80 – Rs. 92 | TP: 117

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RATIONALE Valuations to remain under pressure; strategic changes to pan out over 3 yrs: Company currently trades at P/E of 20.7x and EV/EBITDA 8.03x, however, company has been undergoing phenomenal strategic changes to position itself as a ‘Health Beverage’, global player. This is likely to pan out in it’s entirety over the next couple of years’ (2-3 PAST PERFORMANCE / OTHER DETAILS years) – this specifically would propel the company to a new trajectory; until such time, the company will continue to post decent growth rate and will retain it’s market positioning across domestic and international markets within the tea & coffee segment. They will continue to expand substantially in under/un-penetrated markets, amidst this there will be JVs, acquisitions and partnering with a view to expand it’s presence. For FY12E, we see the company posting higher than tea / coffee industry growth rate; however, it shall remain muted. In the base case, we foresee a topline growth of 7.5%, with EBITDA margins shrinking by 90bps given the cost concerns. We estimate the forward P/Ex @ 25.2x and with EV/EBITDA @ 10.05x, we set a price target of Rs. 117/ over the next 12 months. Margin pressures to stay in FY12: Unlike other FMCG players, FINANCIALS TGB (beverage player) is plagued with the challenge of decline in volumes on price increases; this grossly restricts their ability to pass on the input cost increase effectively to the end users. As per Hackett Financial Advisors Inc., coffee prices, which have doubled in the past year, may rally another 48% to the highest since atleast 1972 as demand outpaces supply (they have already moved up an average ~44%). US contributed 23% of the revenue in FY11 which largely comes from their Eight ‘o clock coffee, this is likely to remain under stress. Tea price have increased approx. ~15%, it is however expected that Tea Prices are likely to stabilize on the backdrop of increased output. Management will take a call on any price increases based on how the commodity prices pan out, simultaneously ensuring that volume’s don’t dampen sharply. We SHARE PRICE TO INDEX estimate the EBITDA margins to shrink by 90 bps, hence the EBITDA margins are likely to fall from 10.9% to 10%. We also estimate the PAT to grow roughly by 1.2% backed by reduction in tax rates which is expected to fall from the current 39.3% to ~37.5%. We have not assumed any accruals from TATA Coffee business wherein the Starbucks’ revenue could possibly start to flow by year end, considering that TGB holds ~57.5% of stake in TATA Coffee, the company could see significant benefit. Source: Capitaline, Right Horizons

TATA GLOBAL BEVERAGES FMCG INDIA Segmental review: Tea segment posted a growth of 2.4%; coffee segment reported a growth of 6.2%; others segment which includes the packaged water / other beverages fell sharply by 11%, however, this contributes ~1% towards the total revenue (YoY basis for FY11); on an EBITDA basis, tea segment fell sharply by 26%; coffee remained flat and others segment saw a steep fall of 11% - this was pre-dominantly due to the increase in raw material cost of 11% and an increase in advertising cost. The company continues to be dependent on Tea with

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Product centric company: TGB has sold majority stake of it’s backend plantations in South India (it holds ~19%); it plans to demerge it’s north Indian plantations as well (currently holds ~49% stake here), there is clear effort to emerge as a product centric COFFEE PRICES company. The company proposes to build a basket of products which focus on unconventional tea products – green /herbal/lemon tea and health beverages. T!on which was one such experimental unconventional tea beverage was moderately successful in the southern region where it was launched. However, the company plans to review this products profitability and accordingly take a long term strategic call. Focus on overseas market: Company currently derives over 75% of it’s revenue from overseas and ~25% from domestic sales – this mix is likely to stay, also given the restrictions within the Tea Industry (export woes, exchange dynamics) in India, it is likely to focus more on overseas markets – amongst the overseas markets UK, Africa, Canada are key for their Tea segment and US for their coffee segment. They propose to strongly under / un -penetrated markets such as - Russia (they have already made a tie-up with Grant), China (where again they have a JV), Poland, Chezh, etc.,

STRATEGIC ALLIANCES

TATA – Pepsi JV to be ‘Root to market’ enabler: TATA & Pepsico joined hands under the 50:50 JV, they have successfully manufactured and marketed ‘Himalayan’ which targets the premium packaged water segment. They aim to provide affordable drinking water for the Indian middle-class segment. Also, they are now in the process of launching a glucose-based beverage called 'Lehar Gluco Plus', a lemon-flavoured, noncarbonated drink, which will be rolled out in pockets of Maharashtra through a pilot project and will be priced at Rs 5. TGB intends to utilize the extensive distribution network of Pepsi to reach out to a wide market to tap the packaged water segment. Source: Commodity Index, Company, Right Horizons

TATA GLOBAL BEVERAGES FMCG INDIA

Strategic positioning: TGB is in talks to sell a 20% stake in its international operations to a strategic investor. This is yet another move to consolidate it’s position in the overseas market and bring in the expertise of a global player. The company has also been keen on expanding it’s presence in the international space via JVs, apart from the Pepsi JV , they have Kerala Ayurveda in the offing, the MoU is yet to be signed, they plan to utilize the ayurvedic expertise to manufacture ‘health beverage’ which will pre-dominantly cater to the overseas market. Further, the company has also acquired 31% stake in Activate (US based vitamin supplement drink Company), they have the option of increasing the stake to over 50%, the company is yet to contemplate on this – they plan to bring this vitamin drink to India, which could cater to the huge sports drink space.

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Huge market potential: ‘Health Beverage’ segment is focused PRODUCT MIX on the urban population which is increasingly becoming health conscious across the world. TATA being the first mover will have a huge advantage given that they would have a basket of products, most of which would have undergone a brief trial period in the market. The challenge here would come in educating the end user about the product; in this sense the Indian markets would limit their growth potential, the overseas market throws up a huge arena. The advertising / marketing / selling expenses would be substantially high during such period. The conventional tea segment growth is curtailed beyond a point, esp. in a country like India, where the tea industry can be categorized into organized and unorganized sector, this calls for the need to diversify. PEER COMPARISON

…There are no direct comparables for this stock, it remains a niche player with a host of unconventional products and it has moved away from the tea plantation maintenance which remains the main focus of any other Tea product company Within the Tea segment, the company enjoys a relatively unparalleled position in the high end segment, however, in the mid segment; they face huge competition from HUL which has a significant market share…


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SECTOR OUTLOOK TEA INDUSTRY – India accounts for 26% of world's production. While Sri Lanka, Kenya and Indonesia are the other leading producers; their combined production is lower than that of India. For the Indian tea industry, the main driver of demand is the domestic market, with domestic consumption now growing at an estimated 3% annually, as against around 2% a decade earlier. Apart from the increase in population, active marketing of tea by companies as well as the Tea Board of India (TBI), positioning of tea as a health drink, and the rising affluence of Indian consumers have all led to an increase in the demand for tea. There has been a turnaround in production of tea in India, which has inturn helped increase the exports as well, thereby the prices are likely to stabilize over the next few months, thereby reducing the input costs – this is the domestic scene. However, the global scenario remains weak; tea output has received a setback with production trend reflecting to be lower than target. Tea production in Kenya—one of the largest producers and exporters of tea — recorded a decline in February 2011 due to hot and dry weather conditions in the main Rift Valley producing areas. Similarly, tea output in Tanzania—Africa’s fourth largest producer — is expected to be lower than target after a drought affected yields.

COFFEE INDUSTRY – In May 2011 Arabica prices fell in relation to their levels in April while Robusta prices recorded a considerable increase, leading to a narrowing of the differential between these two types of coffee. With regard to market fundamentals, it may be noted that the second official estimate of Brazilian production in crop year 2011/12 indicates a total production level of 43.5 million bags, compared to 48 million bags in the previous crop year, a fall of around 10%, which may push up the prices. Total production for crop year 2010/11 is estimated at 133 million bags, representing an increase of 8.1% in relation to the preceding crop year. A price rise of upto $4 / pound is expected in 12 to 18 months. Exports by all exporting countries during April 2011 totalled 9.7 million bags, bringing the cumulative total for the first seven months of coffee year 2010/11 (October 2010 – April 2011) to 62.7 million bags compared to 53.7 million bags for the same period in coffee year 2009/10, an increase of 16.7%.


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HEALTH BEVERAGE INDUSTRY Providing consumers information on what constitutes a healthy and balanced diet and encouraging responsible consumption of all food and beverage products is key for the growth of the Health & Beverage Industry. Growth forecast for organic food and nonalcoholic beverages market in India is estimated to grow at ~9% (2009 – 2014), much lower than ~14.5% (2004-2009), China’s growth will remain the fastest amongst the other developing markets. Euromonitor (2009) estimates that by 2012 the organic products with contribute €24 billion to the estimated €550 billion global health and wellness market. The growth drivers identified for this segment are favorable market demographics, consumerism, globalization, changing lifestyles, increasing availability across categories and regions and rising awareness among people. One of the challenges of R&D within the food and beverage industry is to improve the nutritional profiles of products (e.g. reduced portion size, fat, energy, calories, sugar and salt) while maintaining the taste and aroma of the product and delivering these products to consumers at a reasonable price. GROWTH FORECAST FOR ORGANIC FOOD AND NON-ALCOHOLIC BEVERAGES MARKET

FASTEST-GROWING CATEGORIES/ PRODUCT AREAS ACROSS 38 KEY MARKETS

In terms of payback and gestation periods, products such as health foods and drinks, dietary supplements and alternative medicines require greater investments, normally exceeding Rs 250 million or more. Payback periods range from three to six years. The convergence of Health & Wellness concept with popular beverage Tea could open up new possibilities in this segment.


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BUSINESS OVERVIEW Tata Tea Limited, also known as Tata-Tetley, is the world's second largest manufacturer and distributor of tea. Owned by India's Tata Group, the Tata Tea Limited markets tea the major brands Tata Tea, Tetley, Good Earth Teas and JEMČA. Tata Tea owns five brands in India: Tata Tea, Tetley, Kanan Devan, Chakra Gold, and Gemini. While Tata Tea is the largest tea brand in India, Tetley is the largest tea company in the United Kingdom and Canada and the second largest in the United States by volume and JEMČA is Czech Republic's leading tea company. The company was rechristened as Tata Global Beverages to include the range of health and nutritional beverages it wants to enter into. Set up in 1964 as a joint venture with UK based James Finlay and Company to develop value-added tea, the Tata Tea Group has now product and brand presence in 50 countries. It is one of India's first multinational companies. The operations of Tata Tea and its subsidiaries focus on branded product offerings in tea, but with a significant presence in plantation activity in India and Sri Lanka. As recent developments, company has acquired 31% stake in Activate brands, has JVs with PepsiCo & Kerala Ayurveda. It also holds 57% stake in TATA Coffee.

PRODUCT OVERVIEW TETLEY - In 70 countries around the world, people enjoy the goodness of a cup of Tetley tea; Tetley’s success extends to non-core

products, which have been developed to suit all cultures, tastes and moods GOOD EARTH - It is good to the earth since it uses some of the greenest packaging around TATA TEA - Has been rated as the second most trusted hot beverage brand in India and accorded ‘Super Brand’ status; Is the

leading brand in India (21.4% market share) HIMALAYAN - Is a premium, lifestyle, mineral water brand in India’s top metropolitan markets 8 ‘O CLOCK COFFEE - is the third largest coffee brand by volume in the US retail coffee market; 4.7% market share in the US SHARE HOLDING PATTERN

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