Ratings  agency  ICRA  expects  the  profitability  of  bulk  tea  companies  to  witness  a  material  improvement  in  FY2021 over  the  previous  year,  driven  by rising  domestic tea  prices which have seen a  considerable  uptick  in  6M  FY2021 due  to  a significant supply-demand  mismatch. 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. At the North India (NI) auction centres, average prices of CTC teas were up by ~Rs 105 a kg (~68%) on a cumulative Y-o-Y basis for the period April to September 2020. The corresponding increase in CTC teas from South India (SI) is ~Rs 37 a kg (37%).  For  ODX  teas  at  the  NI  auction  centres,  the  cumulative  increase  is  ~Rs 52 a kg  (22%),  while  at  SI  auction  centres,  itis  only  ~Rs  13 a kg  (10%). Consequently,  full year  price sare  expected to significantly increase on a Y-o-Y basis, with NI CTC teas being likely to be higher by ~Rs 65 a kg (~46%) and NI ODX prices up by  ~Rs  50 a kg  (~25%). This would more than compensate for the expected increase in the cost of production, following the crop loss witnessed in the current year.

Commenting on the same, Kaushik Das, Vice President and Sector Head, Corporate Sector Ratings, ICRA, said, "Due to the favourable price-cost effect, the operating margin of NI-based bulk tea companies in our sample set is expected  to  witness a significant  improvement  to  around  10% in  FY2021,  implying  a  600-bps  increase  on a Y-o-Y basis.  Operating  profitability  in  FY2021  is  likely  to  be  the  highest in  recent  history, with double-digit  operating margins being last recorded in FY2014."

On the global production front, while the Kenyan production significantly increased by ~34% Y-o-Y in 8MCY2020, the  short falls in  production  from  India (a  contraction of  ~19%)  and  Sri  Lanka  (a  contraction of  ~16%)are likely  to result in an overall decline in global tea production in CY2020. A significant increase in Kenyan crop continued the pricing pressure on Kenyan CTC teas, as witnessed by the ~7% price decline of Kenyan teas in 7M CY2020,over and above the ~15%  decline  already  witnessed  in  CY2019. However,  the same  has  not  impacted  Indian  CTC  prices,  as domestic CTC tea is primarily consumed (~90%) 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 teas 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 teas in the international  market, supports the  demand  of Indian ODX teas,  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% in 7M CY2020. And is likely to be lower in the current calendar year, given the lower export to Iran. While the export volume is expected to moderate, the  domestic  demand remains robust, leading  to a supply-demand mismatch, thus favouring tea prices.

The improvement  in the operating profits of  NI-based  bulk  tea players, triggered  by the expected  increase  in realisation by around Rs 50-65 a kg, more than offsetting the likely increase  in the cost of production by around Rs 25-Rs 30 a kg, would also lead  to  an  improvement  in their debt  coverage  indicators. While  an aggregate  (of companies in ICRA's sample set) interest coverage and Total Debt/OPBDITA of around 2.5-2.7 times and ~4.0 times respectively, estimated in FY2021,will be a significant improvement compared to less than 1.0 times and over 12.0 times  respectively in  FY2020,  at  an  absolute  level the debt  coverage  indicators would continue  to remain depressed.

"While  FY2021  is  likely  to  turn  out  to  be  one  of  the  better  years  for  NI  bulk tea companies in  recent  history, providing  the  industry with  some  respite, the long-term  sustainability  of  the  same  remains  to  be  seen.  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," Das reiterated.