Demand-supply mismatch to boost profitability of bulk tea cos in FY21: Icra

Bulk tea companies are likely to see a significant improvement in profitability during the ongoing financial year due to rise in domestic prices on account of a noticeable supply-demand mismatch, ratings agency Icra said in a report.

Domestic tea prices have seen a considerable uptick in the last six months due to a significant supply-demand mismatch, Icra said.

This will lead to material improvement in profitability of bulk tea companies in FY21 over the previous year.

While the increase in prices has been witnessed in both the crush-tear-curl (CTC) and the orthodox (ODX) varieties of tea, the improvement in CTC tea prices has been much steeper than the ODX teas, it added.

At the North India (NI) auction centres, average prices of CTC tea were up by Rs 105 (68 per cent) per kg on a cumulative year-on-year basis during April-September.

The corresponding increase in CTC tea from South India (SI) is Rs 37 per kg (37 per cent), the report stated.

Consequently, full year prices are expected to significantly increase on a year-on-year (Y-o-Y) basis, with NI CTC tea being likely to be higher by Rs 65 per kg (46 per cent) and NI ODX prices up by Rs 50 per kg (25 per cent).

This would more than compensate for the expected increase in the cost of production following the crop loss witnessed in the current year, the report said.

"Due to the favourable price-cost effect, the operating margin ofNI-based bulk tea companies in our sample set is expected to witness a significant improvement to around 10 per cent in FY21, implying a 600-bps increase on a Y-o-Y basis," Icra Vice President and Sector Head, Corporate Sector Ratings,Kaushik Dassaid. said.

"Operating profitability in FY21 is likely to be the highest in recent history, with double-digit operating margins being last recorded in FY1," he added.

On global production front, the report said while the Kenyan production significantly increased by 34 per cent Y-o-Y in eight months of 2020, the shortfalls in production from India (a contraction of 19 per cent) and Sri Lanka (a contraction of 16 per cent)are likely to result in an overall decline in global tea production in 2020.

A significant increase in Kenyan crop continued the pricing pressure on Kenyan CTC tea,as witnessed by the 7 per cent price decline of Kenyan tea in seven months of 2020, over and above the 15 per cent decline already witnessed in 2019.

However, the same has not impacted Indian CTC prices, as domestic CTC tea is primarily consumed (90 per cent) within India.

The demand for it continued to remain firm, with the increase in 'at-home' consumption more than offsetting the decline in 'out-of-home' consumption during the lockdown period.

In addition, the quality and export market of Indian CTC tea differ from Kenyan teas and are thus unlikely to materially impact Indian CTC tea's export performance in the current year.

On the other hand, a lower Sri Lankan production of low-grown ODX variety, which is the primary competitor of the Indian ODX tea in the international market, supports the demand of Indian ODX tea, notwithstanding the decline in Indian export volumes to Iran in the current year, owing to payment-related issues.

Overall, the export volumes have witnessed a decline of around 18 per cent in seven months of 2020 and are likely to be lower in the current calendar year, given the lower export to Iran, Icra stated.

"While FY21 is likely to turn out to be one of the better years for NI bulk tea companies, providing the industry with some respite, the long-term sustainability of the same remains to be seen," Das said.

"The price trajectory next year, once the production returns to normal levels, coupled with the trend in wage rates would remain the key factors determining the financial performance of bulk tea companies in the medium term," he added.