Hold McLeod Russel; target of Rs 151: ICICI Direct

With an improvement in weather conditions, Kenyan production has recovered significantly with 70 mkg YoY increase till August 2016 putting pressure on Mombasa auction prices that have declined 14.8% YoY for nine months ending September 2016 to US$2.3/kg. On the other hand, overall domestic production is estimated at 1190-1200 mkg in CY16, which is at similar level as last year (Indian production was at 1191 mkg in CY15, down 16 mkg YoY). We expect domestic sales volume to decline by 4% in FY17E and recover moderately by 2% in FY18 with muted realisation growth. Thus, we are estimating domestic revenue will remain flat in FY16-18E to Rs 1094.2 crore. Additionally, employee cost has increased from 39.7% of net sales in FY16 from 32.5% in FY12 and is further expected to increase to 44.0% on account of revision in wages and high welfare cost, putting EBITDA margin under pressure.

With a 70 mkg increase in Kenyan tea production until August 2016 & 15% decline in Mombasa auction prices until September 2016, we expect tea prices to remain under pressure. In the backdrop of a subdued demand environment and pricing under pressure, increasing employee cost (from 39.7% of net sales in FY16 to 44% in FY18E), we expect the company’s operating performance to remain under pressure. We remain cautious on the growth outlook and continue to maintain our HOLD recommendation on the stock with a target price of Rs 151.