Steaming along merrily, the stock of Tata Coffee is up 38 per cent from January this year. Even so, this is far below parent Tata Global Beverage’s 64 per cent gain. The two have found favour with global coffee chain, Starbucks, partnering the latter and sourcing coffee beans from the former in its recent India foray.

Even so, at Rs 1,059, Tata Coffee is at 16 times trailing 12-month earnings per share, at the lower end of its valuation band in the past three years. Its US retail operations, which account for the bulk of revenues, have picked up recently after a hard year. Supply to coffee behemoth Starbucks’ Indian operations will also help it tide over the cyclicality typical of commodity plays. Share of premium, higher margin, coffees is also inching up.

Investors with a one-to-two year perspective can buy the stock. However, given the stock’s small-cap status, investors are advised to allot only a small portion of their portfolio to the stock.

Tata Coffee grows, cures, and processes coffee beans. It exports both beans and instant coffee, with exports accounting for 62 per cent of standalone revenues. Through its US subsidiary Eight O’ Clock Coffee Company, it is into the retail side of operations — this division contributed 67 per cent of consolidated revenues in the previous fiscal.

Besides, a small share of revenues comes from tea and smaller crops such as pepper, cardamom and timber.

Support to prices

Export prospects for Tata Coffee depend on the relative price trends and offtake of the Arabica and Robusta varities. Higher-quality Arabica coffee accounts for about 23-27 per cent of total production for Tata Coffee, the rest being Robusta. Production of this crop dipped 13 per cent in the previous fiscal on poor weather conditions. The current season, though, is likely to see an uptick on now-favourable weather conditions.

Over 2010 and most of 2011, Arabica prices almost doubled. This made the cheaper Robusta bean far more attractive for blended coffees — in the year to date, price of this coffee is up 16 per cent. Arabica prices have corrected 30 per cent in the period. A strong Brazilian crop this year is further weighing on Arabica prices.

But demand for instant coffees, which chiefly use Robusta beans, is set to rise on the back of new markets such as South-East Asia. A steep fall in Robusta prices thus seems unlikely.

Bounce back

The correction in Arabica prices will provide a leg-up to Tata Coffee’s Eight O’ Clock coffee US retail operations, which uses this bean as input. At Eight O’ Clock coffee, rocketing prices had forced product price hikes; initiatives such as single-serve packs to push consumption resulted in reduced shelf space for larger-size packs. Volumes dived and almost wiped out profits before taxes for the division for the fiscal 2011-12. Sales were up 14 per cent. Lower input cost now, coupled with gradual resumption in demand, adjusted to price hikes, are likely to help improve profitability this year. Eight O’ Clock coffee is the third largest brand in the US. Priced at a discount to behemoth Starbucks, the company also benefits from customers trading down to cheaper products.

Exports rise

Exports for Tata Coffee clocked an annual 20 per cent growth over the past three years. In the export market, the company has focused on two aspects.

One, increasing the share of higher quality, differentiated coffees which afford a price premium of about 10 per cent over green coffee beans. The share of such coffees in total exports has grown to 37 per cent in 2011-12 against the 23 per cent two years ago.

Two, reducing dependence on Russia for exports, and forays into markets such as West Africa, Japan and Korea which are also large coffee-importers, has resulted in a more diversified client base. Share of non-Russian markets, at 29 per cent for FY-12, is up from the 22 per cent two years earlier.

Domestic promise

Domestic demand for instant and speciality coffees too is picking up as the coffee culture takes hold. Tata Coffee also has a deal to supply roast and ground beans to Starbucks’ Indian operations.

With the first outlet already operational, and the expansion plan charted out by Starbucks, this deal will help increase realisations outside instant coffee, currently at about 8 per cent of total sales. Tata Coffee has recently commissioned a new roastery to supply Starbucks.

Tata Coffee’s consolidated sales grew 12 per cent annually over the past three years. Steadily declining interest costs helped net profits clock a 47 per cent growth in the same period. But high material prices led to a steep slide in operating margins to 11 per cent.

Margins for earlier years stood at 17-19 per cent. But with input prices correcting over the past several months, the April-September period this year saw margins surge back to 18 per cent. Sales for the period grew 18 per cent while net profits doubled.

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