Hold McLeod Russel; target of Rs 166: ICICI Direct

Following the significant increase in domestic tea prices in FY13, tea prices in FY14 witnessed only a modest increase following a revival in production in FY14. The Indian tea industry was negatively impacted by dry weather conditions in India in FY15 and substantially lower prices in global markets, except India, due to geopolitical unrest and currency fluctuations among consuming countries (Russia, Middle East, Pakistan, and Egypt). The increase in domestic and international prices in FY13 was aided by crop loss across India, Kenya and Sri Lanka (key exporting nations to the world economy). However, with a revival in production for Kenya (highest ever production in past 10 years at 445 mkg in 2014 & 432 mkg in 2013) and Sri Lanka in FY14 and record high production of 1200 mkg in India, export prices witnessed moderation. As domestic production in FY15 was marginally lower, domestic prices saw an increase of Rs 6/kg. With dry weather conditions having impacted the Kenyan crop in CY15, tea production declined to 400 mkg while Mombasa auction prices increased 20% YoY. However, there are signs of recovery in Kenyan production (up 60 mkg YoY until May 2016), Mombasa auction prices have declined 11% YoY until June 2016. On the other hand, weather conditions in India barely improved in CY15 compared to dry weather in 2014. Indian production at 1191 mkg was down 16 mkg in CY15. Going forward, domestic and global demand is expected to support price of Indian tea.

High employee wages continue to remain our concern; maintain HOLD With a 60 mkg increase in Kenyan tea production until May 2016 & 11% decline in Mombasa auction prices until June 2016, we expect pressure on international tea prices to sustain. Domestic prices are expected to remain stable in the medium term. However, wages are likely to increase at a more rapid pace. We expect this to continue to pressurise margins for the company. We value the company at 12x FY18E EPS of Rs 13.4 and arrive at a target price of Rs 166/share with a HOLD recommendation.