In the current year, tea realizations are expected to remain buoyant following higher demand for tea, particularly given the expected supply side issues in both Sri Lanka and Kenya.
However, buying patterns across tea segments, which had witnessed a considerable change in CY2016, will remain a key determinant of the overall price trajectory in the current year as well.
Despite the buoyancy in prices though, continuing cost pressures, with the increase in wage rates, are likely to keep the margins and debt coverage indicators of bulk tea producers under check. Nonetheless, the capital structure of large companies in the sector is expected to remain favorable.
During CY2016, the aggregate tea production across India, Kenya and Sri Lanka increased by around 3.5 percent, primarily due to a surplus in the Kenyan crop. Indian production during CY2016 was also up by around 2.5 percent, due to an increase in the North Indian crop, which accounts for over 80 percent of the total bulk tea production.
The Sri Lankan crop, on the other hand, witnessed a steep decline of around 11 percent. In the current year however, the overall global production trend is unlikely to witness the same trajectory as last year.
"Initial weather forecasts indicate lower rainfall in Kenya during the first quarter of CY2017, which is likely to impact production from the region. Since Kenya is the largest exporter of black tea, its production levels have a significant bearing on the availability of tea in the global market. Moreover, Sri Lankan production, which is primarily of the orthodox kind, is likely to continue to remain under pressure, leading to increased export demand for Indian orthodox tea. Such supply-side issues are likely to have a favorable impact on both international and domestic tea realizations," said VP and Sector Head Corporate Sector Ratings ICRA, Kaushik Das.
Notwithstanding India's large domestic consumption base, exports play a vital role in maintaining the overall demand-supply balance in the domestic market.
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"Buying patterns will also be a key determinant of domestic price levels in the current year as well," added Das.
An increased proportion of lower quality CTC tea purchases in CY2016 led to a rise in prices for lower segment CTC teas, which, in turn, supported overall CTC realizations. Moreover, prices of bought leaf also increased on account of this change in buying patterns, while higher quality estate leaf prices witnessed a downtrend.
Notwithstanding the expected increase in tea realizations, the margins of bulk tea producers are likely to stay under pressure. With tea being a fixed cost-intensive industry, labour costs have accounted for a significant portion of the total cost of production in past years.
Over the last two years, the cost of production of bulk tea players in North India, has increased by nearly 23 percent on account of increased labour costs.
The same is attributable to a steep rise in wage rates, which increased by around 25 percent in both Assam and the Dooars during FY2014-16. In FY2017, too, wage rates are scheduled to increase by an additional eight to nine percent across the tea-growing regions in North India, resulting in continuing pressures on the profit margins of bulk tea companies, despite the increase in domestic average auction realizations.
The credit-worthiness of large companies in the sector, however, is expected to continue being supported by a favorable capital structure.