ICICI Securities bullish on Tata Tea

Broking house, ICICI Securities is bullish on Tata Tea . It has reiterated buy rating on the stock.

The report ICICI Securities on Tata Tea:

Key takeaways from Tata Coffee conference call

"We remain positive on Tata Tea after our recent conference call with Tata Coffee's management - Tata Coffee is a 51% - owned subsidiary of Tata Tea. Eight O'Clock Coffee, EOC, acquired by Tata Coffee in a leveraged buyout, is a highly profitable and fast growing business, which easily justifies EV/EBITDA multiple of 8x on a trailing basis."

"While EOC continues to register robust growth in its core business, Tata Coffee plans to widen its geographical reach to the Western part of the US, CIS and Eastern European counties in order to leverage the strength of the group's reach. We believe that the acquisition would not only be earnings-accretive but also support a re-rating as the group moves towards becoming a global beverage player.

EOC, a profitable and fast-growing business

"EOC is a fast-growing company - its revenues grew from USD 65 million to USD 109 million over the past three years. After EOC was hived off from the super market chain Great Atlantic and Pacific Tea Company, it carved a larger market share, automatically broadening its presence across the states of its operations. Apart from the expansion, a new, dynamic and vibrant management team was put in place leading to a robust growth for EOC over the past three years."

"EOC is segmented in the value gourmet segment, positioned below Starbucks, but above Folgers (P&G) and Maxwell House. Further, it is a market leader in the whole-bean coffee segment - the company has retail distribution strength and approximately 67% of all commodity volume penetration of the US retail coffee market. Supported by EOC's market leadership in the whole-bean coffee segment, the business is highly profitable and operates at a 25% EBITDA margin. The acquisition price at EV/EBITDA of 8x for CY05 is justifiable based on robust growth and high profitability of the business."

A leveraged buy-out

"Out of the total acquisition cost of USD 220 million, Tata Coffee plans to fund USD 40-50 million through equity and the balance USD 170-180 million through non-recourse debt from Rabo Bank. Similar to the acquisition of Tetley, Tata Coffee would be ring-fenced against the debt. The terms of debt are in the final stages of being finalised and management does not rule out the consolidation of operations of the Tata Tea group companies at a later date."

Leveraging the acquisition

"EOC provides Tata Coffee with a sizeable entry platform and an established brand in the largest coffee market - the US - coffee sales are estimated to be around USD 21 billion in the country. Further, Tata Coffee plans to leverage EOC's strong brand equity. EOC is presently confined to the Eastern part of the US and Canada, while Tata Coffee has a sizeable presence in instant coffee markets of Russia, CIS, Ukraine, and East European countries (it sells around 5,000te of instant coffee annually, mostly under private label)."

"Therefore, there is a big opportunity for EOC and Tata Coffee to use EOC's brand and launch an instant coffee product in these countries, where the growth is phenomenal - a compounded yearly rate of around 11-15%. Further, Western brands or American brands are perceived to be superior in these countries, therefore, the chances of the brand being successful in such markets is higher as against the Tata Coffee brand. Tata Coffee is in the process of completing a freeze dry coffee plant, which would help it in offering top-of-the-line quality in the instant coffee segment. This would go well along with the EOC image."

"Jemca, a leading tea company acquired by Tata Tea in Czech Republic, would also provide a platform for widening the company's reach in the Czech market. Besides, EOC would expand to Western US with the help of Good Earth Tea, which has been recently acquired by Tetley. Therefore, from being a brand that is currently available only in the Eastern US, Tata Coffee plans to significantly expand through leveraging its own and Tata Tea group's distribution strength. Moreover, Tata Coffee would undertake cost-cutting measures at EOC in order to further improve its profitability."

Key initiatives by Tata Coffee

"Tata Coffee is setting up a state-of-the-art freeze dried plant at Madurai with a capacity of 2,000te per annum - this would increase value addition and lead to an improvement in realisations. Further, Tata Coffee is in the process of signing an agreement with the Government of Uganda for an instant coffee plant with a capacity of 3,600te. This would be a 100%-export oriented unit, manufacturing agglomerated and powdered instant coffee."

Eco tourism

"Tata Coffee has major plans of developing Eco tourism in Coorg and other planting districts. Coorg has become a hot tourist destination due to its proximity to Bangalore. Tata Coffee has received an overwhelming response for its effort. It has already converted around four bungalows with about 16 rooms, and has plans to convert another six bungalows this year. The company might even consider building new bungalows for this project. Each bungalow has a potential to generate revenue of Rs 10 million per annum."

Acquisition to be earnings-accretive and support a re-rating

"Our back of the envelope calculations suggest that the acquisition of EOC can potentially add an EPS of around Rs 4 (7%) for FY08E to Tata Tea. However, the consolidated balance sheet would become more leveraged. The acquisition would widen the product portfolio and geographic reach of the Tata Tea group. This is a step forward towards becoming a global beverage player and would lead to a re-rating of the company. We reiterate Buy on Tata Tea, which is currently trading at FY07E P/E of 14x."