How to do Business Analysis of Tea Producers

The current article aims to highlight the critical aspects of the business of tea-producing companies, tea estates etc. After reading this article, an investor would understand the factors that impact the business of tea producers and the characteristics that differentiate a fundamentally strong tea company from a weak one.

First, let us understand some key but basic aspects of tea production in India.

Important aspects of tea production

1) Tea production regions in India

Tea production requires a specific climate: temperature from about 25 to 35 degrees Celsius and continuous, evenly spread rainfall. Alongside, high rain, tea bushes require good water drainage because stagnant water harms the bushes. As a result, tea is produced in hilly areas, which receive plenty of rain.

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temperatures in the range of mid-20 degree Celsius to mid-30 degree Celsius, with rainfall evenly spread out over the period. Tea cultivation needs well drained land as water stagnation is detrimental to tea bushes

Two areas in India meet these conditions and have become major tea-producing regions. Northern areas (Assam and West Bengal) produce about 80% and southern areas (Karnataka, Tamil Nadu and Kerala) produce about 20%.

In Northern areas, tea is produced during a nine-month-long season (March to December) whereas in the southern areas, tea is produced around the year.

Most of the tea produced in India is black tea and India is the largest producer of black tea in the world, producing about 40% of the world’s production.

2) Orthodox and CTC tea:

Tea is mainly produced by two methods: orthodox and CTC (crush, tear and curl).

In orthodox tea production, the tea leaf is kept intact i.e. uncrushed whereas in the CTC tea production, leaves are crushed, rolled and broken into small granules. CTC process of tea production is quicker and also it provides rapid flavour extraction in final tea preparation. Therefore, CTC tea is used in mass consumption e.g. in tea bags etc. Whereas, orthodox tea takes much more time in production as well as final preparation.

As a result, CTC tea is cheaper and is used for general consumption whereas orthodox tea is premium and is used by tea enthusiasts to enjoy the art of tea making.

In India, most of the tea production is CTC and is for domestic consumption whereas a small amount of tea production is orthodox, which is premium and is primarily exported. The price of orthodox tea is primarily influenced by global factors of supply and demand.

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Historically, the orthodox variety of tea has commanded a premium over the CTC variety. However, orthodox tea is largely exported and hence realisations of such a variety have a stronger linkage to prices in the global markets. The Indian domestic consumption is almost entirely of the CTC variety.

In India, Darjeeling tea is mostly orthodox, is of premium quality and is largely exported.

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Darjeeling tea, comprising around 1% of the North India production, is known for its high quality, which is of the orthodox variety and is largely exported

3) Demand for tea is sustained without any risk of sharp decline:

Tea is a very popular drink, which is consumed by a wide section of the population. It is a low-cost drink, which can be easily prepared at home. So, it does not create any issue of affordability for consumers. As a result, tea producers do not have to worry about the demand for tea and focus on maximizing the supply, which is the biggest factor in determining the cyclicity of the tea business.

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environmental factors pose supply-side risks, the demand side risks are largely protected as tea is one of the most popular, widely consumed and low-cost beverages.

In fact, over the years, the consumption of tea has grown at a fast pace. In the past, the demand for CTC tea, which is consumed by the masses increased sharply, which reduced the premium/pricing difference between CTC and orthodox tea.

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With consumption increasing at a faster rate than production, prices of CTC teas have also witnessed a healthy increase, leading to narrowing of the premium that orthodox teas have traditionally enjoyed in the domestic market.

Also read: How to do Business Analysis of a Company

Now, let us understand the key factors affecting the business of tea-producing companies.

Key factors influencing the business of tea producers

1) Agro-climatic risks in tea production:

As with all agricultural products, tea requires a specific climatic condition: temperature, rainfall and humidity. If any of these parameters is not right, then it adversely affects tea production.

Apart from climatic conditions, like all agricultural corps, tea production is also susceptible to pest attacks.

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Tea, being an agricultural commodity, is susceptible to agro-climatic risks, with the production and quality of tea being primarily dependent on prevailing weather patterns. The crop is also exposed to pest attack issues,

Due to uncertainty of weather conditions, tea production sees high fluctuation from one year to another impacting the revenue and profitability of tea companies.

2) Cyclicity and seasonality in the financial performance of tea companies:

Due to the high dependence on rainfall, tea production depends on monsoon performance in any region. As monsoon performance is usually cyclical with a few years of good rains followed by a few years of less rains (draught), therefore, tea production also shows cyclical trends leading to year-on-year fluctuations in the performance of tea companies.

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However, tea being a cyclical industry, profitability varies significantly through the cycle.

In addition, to year-on-year cyclicity, tea production, especially in northern areas (Assam and West Bengal) also witnesses seasonality.

In line with the availability of rain, in the northern areas, the season of tea production lasts for nine months whereas in the southern areas, tea production happens around the year.

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In North India (NI), the tea-growing season is for around nine months—from mid-March to mid-December…In South India (SI) it is produced through the year

As a result, in the northern areas, the quarter-on-quarter measurement of production performance does not give any meaningful conclusions.

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there is a wide variation in QoQ performance of a North India-based bulk tea players, since the major production happens during April to October period. Thus, QoQ/ sequential comparison is not relevant as much as a YoY analysis.

Moreover, tea companies in northern India get the best pricing for their tea for production in May and June when the tea bushes produce the second batch of tea leaves called “second flush”, which is the best quality and gets premium pricing.

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Realisations can also vary across months with the “second flush” batch of teas, produced during May and June in Assam, commanding the maximum price because of its premium quality compared to tea produced in the other months of the year.

As a result, the financial performance of tea companies witnesses significant fluctuation quarter-on-quarter as well as year-on-year due to seasonality and cyclicity; thereby, creating difficulty and high uncertainty in predicting their future performance.

Also read: How to analyse New Companies in Unknown Industries?

3) Very high labour cost, which is fixed in nature:

Tea production is very labour-intensive as it requires significant manual work. For example, tea leaves need to be plucked by hand from the bushes. Moreover, a large number of labourers are needed to take care of tea plantations over the years.

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Tea is among the most labour-intensive of all plantation crops.

As a result, labour cost constitutes about 65-70% of the overall production cost of tea.

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Tea is a fixed cost-intensive industry with labour costs accounting for around 65-70% of total cost of production.

The requirement of labourers by tea estates/gardens depends on their size and remains constant irrespective of the production of tea in any particular year as the life of tea bushes extends even 50 years. So, once a certain size/acreage of tea bushes is planted, then it would continue to require a certain number of people for their care and plucking year after year.

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The number of labourers required by each estate remains largely constant, regardless of production levels, thereby imparting a fixed nature to the cost of labour.

An investor would appreciate that when the largest cost component (labour cost) of tea production is almost fixed in nature, then any change in the revenue of the company will lead straightaway impact its profitability.

Therefore, cyclicity and seasonality of tea production lead to very significant volatility in the profit margins of tea companies.

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the inherent supply-side cyclicality of the fixed cost-intensive tea industry leads to significant variability in profitability and cash flows of bulk tea producers.

Due to the high labour-intensiveness of tea production, tea companies need to maintain very cordial relationships with the local community, which supplies workers to the tea gardens.

Usually, whenever any business impacts a large section of the local population, then local politicians and govt. agencies tend to influence their functioning. In tea plantation regions as well, trade unions and govt. influence wages of labourers.

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The stakeholders of a tea production business include, inter alia, local communities and Government authorities, which influence the operating environment of the business.

As political considerations force govt. to influence wage rates of tea plantation workers, it nudges the tea companies to pay a higher wage to workers year after year. Due to such govt. actions, the cost of production of tea estates continues to increase consistently.

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The wage rates for tea estate workers are regulated by the Government and are revised regularly as the level of wages and welfare costs for tea estate workers have significant socio-economic implications.

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the increase in the cost of production of bulk tea players over the last few years has primarily been driven by increased labour costs

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The increase in wage rates affected by the Government of Assam and Governments of West Bengal has led to a high cost of production.

As larger tea estates face the issue of a large, nearly permanent labour force leading to an almost fixed/sticky labour cost; therefore, at times, small tea estates have an advantage as they have a lower fixed labour cost to take care of.

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significant difference in cost structure of small growers and organised players reduces the competitiveness of the organised players

As a result, more than half of tea in India is produced by small tea gardens.

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Around 52% of the total tea production in India is currently produced by small growers.

Also read: Credit Rating Reports: A Complete Guide for Stock Investors

4) Diversification of operations strengthens the business model of tea estates:

4.1) Geographical diversification:

Tea production is impacted by weather patterns in the region. Therefore, any tea company that has tea estates spread across different locations can reduce the risk of a significant adverse impact on its overall financial performance if any one region witnesses lower rainfall or pest attack etc.

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geographically diversified tea-producing entities are seen to be less susceptible to adverse agro-climatic conditions affecting specific regions.

As tea is consumed across India; therefore, any tea company with geographically spread tea estates has the added advantage of being closer to the markets and saving on logistics costs.

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a diversified production base, with its presence in different geographies also provides easier access to the different markets.

4.2) Flexible production in tea plantations gives an advantage:

As discussed earlier, CTC tea is cheaper and is for mass consumption whereas orthodox tea is costly and is of premium quality. CTC is mostly consumed within India and orthodox tea is primarily exported.

As a result, both CTC and orthodox teas have their own pricing factors. At times, when orthodox tea provides a significantly large profitability proposition, then those tea gardens that have a flexible manufacturing process and can shift from CTC to orthodox tea manufacturing, gain an advantage as they can produce more orthodox tea and earn a higher profit.

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ICRA, therefore, evaluates the entity’s capability/flexibility to switch production between the two varieties of teas in response to market conditions.

4.3) Access to irrigation system:

Due to high agro-climatic risk, those tea plantations, which have access to irrigation systems have an advantage over those plantations without any irrigation system relying primarily on rain.

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ICRA also evaluates the ability of a bulk tea-producing entity to partially mitigate such agro- climatic risks through access to an established irrigation system and the extent of coverage of such systems as a proportion of the total tea-bearing land.

4.4) Using bought tea leaves in production:

Large tea producers, at times, have tea processing capacity in excess of the leaf production from their gardens. Therefore, they frequently resort to buying tea leaves from smaller tea gardens, which increases the tea production of large producers, increases their revenue and profits and in turn, helps them overcome the impact of large fixed-in-nature labour costs and reduces the volatility in financial performance.

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ICRA also evaluates the share of bought leaf operation, in the overall size of the entity’s business, since it helps reduce the effect of volatility in bulk tea prices.

Manufacturing tea from bought leaves usually has a lower profit margin than leaves grown within one’s own gardens as the prices of raw tea leaves move in line with the final tea prices. However, increasing the utilization of tea processing equipment, helps the larger tea producers earn relatively stable profit margins.

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Bought leaf operations provide stable, albeit low, margins as green leaf prices move largely in tandem with end- product realisations.

5) Large-sized tea producers benefit from economies of scale and efficiency:

Given the fixed cost-intensive business of tea production due to large labour costs, tea producers with a large scale of operations are able to benefit from economies of scale and make their operations more efficient with increasing production.

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Bulk tea production is a fixed cost-intensive business, with labour costs accounting for a significant portion of the total cost of production. Thus, a larger scale of operations, which allows for better absorption of fixed costs

In addition, large-sized tea producers show greater financial strength and flexibility to raise funds. It helps large players survive the uncertainty of financial performance in different phases of the business cycle.

Large players also benefit from buying tea leaves from smaller plantations to increase tea production from their plants and increase their profitability.

Large players, given their business size, also benefit from diversification in operations.

In the tea industry, efficient players are usually large tea producers due to economies of scale benefits, which if have a premium quality product, then they have a competitive advantage to face business cycles better.

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producers with efficient cost structures and premium quality produce are observed to perform better across cycles

Also read: Operating Performance Analysis: A Simple & Complete Guide

6) Govt. support and subsidies for tea producers:

As tea plantations are very labour-intensive and the industry has a significant impact on the local socioeconomic situation; therefore, govt. provides many incentives to the industry.

6.1) Replantation/rejuvenation subsidies, for the production of orthodox tea and transportation:

Tea bushes have a very long life of even exceeding 50 years. Therefore, at any point, every tea plantation has bushes of different ages.

Younger/new plants provide higher tea productivity. As a result, tea gardens have to undertake replantation and rejuvenation exercises to maintain the age profile of the bushes to maximize production at a lower cost.

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The age profile of the bushes, together with the out-turn ratio, determines the overall productivity per hectare. The constitution of tea bushes within the productive age bracket of 4-50 years is considered to be favourable for better productivity, given that young bushes have higher productivity.

To promote a higher productivity, govt. gives subsidies to tea gardens to undertake replantation and rejuvenation.

In addition, govt. also provides subsidies for the production of orthodox tea, which is premium and is mainly exported.

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industry-wide benefits/subsidies, which include re-plantation and rejuvenation subsidy, the subsidy on the production of orthodox tea

In addition, some state govts. also, give more subsidies like transport subsidies for the export of tea.

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Additionally, there are some region-specific subsidies / benefits too, like the one on transportation expense for exports through the dry port of Inland Container Deport at Amingao (Assam).

6.2) Rebates on custom duties:

Govt provides incentives to tea exporters under its various schemes.

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Apart from good prices, bulk tea exporters also receive monetary benefits under the Remission of Duties or Taxes on Export Products Scheme (RoDTEP) and the Duty Drawback Scheme for the volume of exports undertaken, which adds to their income and profits.

6.3) Schemes for reduction of tax outgo for tea producers:

Tea producers can deposit up to about 40% of their profits with the National Bank for Agriculture and Rural Development (NABARD) and can get tax rebates on such deposits under the Income Tax Act.

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bulk tea producers can set aside a part of the profits with the National Bank for Agriculture and Rural Development (NABARD) to reduce tax liabilities…Lower of the amount deposited with NABARD or 40% of the profit computed under ‘Profits and gains from business or profession’ is eligible for deduction under Section 33AB of the Income Tax Act, 1961

7) Ratios and parameters important for tea producers:

7.1) Productivity of the tea estate:

A tea producer’s productivity is measured as kilograms of tea produced per hectare of planted land.

As tea production is a very high fixed-cost business with large labour costs, any improvement in productivity in tea production provides a significant operating leverage and resultant increase in profit margins.

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Productivity of the estates, measured as kilograms of tea produced per hectare of tea-bearing land, is an important measure of the operating efficiency, as in a fixed cost-intensive business like tea, higher yield directly supports the cost structure and hence profitability.

7.2) Out-turn ratio:

Another key productivity parameter for tea producers is how much tea they are able to produce from tea leaves consumed including both own plantation as well as bought leaves.

A higher out-turn ratio indicates better operating efficiency of the tea producer.

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The out-turn ratio, which measures the tea produced as a percentage of green leaves consumed, is also an important measure of operating efficiency.

7.3) Realization of tea of a producer vs auction average price:

Tea prices are generally determined by the demand and supply situation in the global market. However, if the quality of tea from any tea plantation is good, then it gets a premium in the market.

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Realisations from black tea are to a large extent a function of the demand-supply situation in the global tea market, and the quality of the product.

One way to determine the quality of tea from any plantation is to compare its weighted price of tea over the year with the average prices of district and national auctions.

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ICRA compares the weighted average realisation of the rated entity with that of the district and national auction averages to assess the relative quality of the produce of the entity. Higher average realisation, indicating better quality of produce

Also read: How to do Financial Analysis of a Company

Summary

Tea production is a cyclical business activity where agro-climatic risks bring uncertainty to production. Intermittent periods of poor monsoon/draught, pest attacks etc. affect tea production. As a result, the financial performance of tea-producing companies is very fluctuating.

The fluctuation/cyclicity in the tea business is mainly due to variations in production because due to its low-cost nature, it is a widely consumed beverage generating healthy demand.

The high labour cost of tea production (60-70% of the total cost of production) is almost fixed in nature and therefore leads to large variations in the profit margins with small changes in revenue/tea production. In addition, labour cost increases continuously as the govt. determines the wage rate of labourers at tea plantations and revises it upwards due to economic as well as political reasons.

Local politicians, regulators and trade unions significantly influence the operations of tea plantations because these plants have a significant impact on local socioeconomic life.

In addition, govt. provides a lot of subsidies to tea producers to improve efficiency and profitability by replanting tea bushes, producing and exporting premium quality tea and tax breaks.

Nevertheless, due to agro-climatic risks, tea producers face region-specific challenges. As a result, tea producers with geographically spread-out plantations benefit from reduced risk of agro-climatic challenges as well as better access to different markets.

Large diversified tea producers benefit from economies of scale, better financial strength and flexibility, the ability to buy tea leaves from smaller gardens to increase their production, better operating efficiency, flexibility to switch production from CTC to orthodox as per market situation etc.

An investor should always keep in mind these multiple aspects of tea producing companies to understand their business position.

• Unpredictability weather and pest attacks leading to fluctuations in production and revenue
• Cyclicity and seasonality in financial performance
• high volatility in profitability due to the fixed nature of large labour costs
• Large tea producers have distinct competitive advantages
• Geographical diversification of plantations, flexibility in making CTC and orthodox tea, ability to buy tea leaves from smaller gardens to increase their capacity utilization bring strength to a film company’s business model
• supports as well as interferes with the business operations of tea producers. So, it is a comfort as well as a risk. Investors need to be cautious and continuously monitor policy initiatives and changes impacting the tea industry.
• Investors should focus on productivity, out-turn ratio, and premium in average realization over auction averages to determine whether a tea producer is efficient and has a quality product.

We believe that if an investor analyses any tea producer by keeping the above factors in mind, then she would be able to assess its business properly.

Regards,
Dr Vijay Malik

P.S.

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Disclaimer

Registration status with SEBI:

I am registered with SEBI as a research analyst.

Details of financial interest in the Subject Company:

I do not own stocks of the companies mentioned above in my portfolio at the date of writing this article.