Harendra Kumar

Measured aggression is a good trait to possess, especially when it comes to running businesses. Take the case of Tata Global Beverages (TGB), which under its new CEO, Harish Bhat, is displaying an unseen aggression as it looks to reduce dependence on its core tea and coffee businesses. After taking over the reins at TGB in mid-2012, Bhat — who, as former COO, had played an important role in building the watches and accessories business at Titan — is charting a slightly different course. For one, the much talked-about foray into the foods business is no longer part of the strategy. Instead, Bhat is looking at a bigger play in the beverages category. More importantly, some of the new ventures that TGB has entered into will have a positive rub-off on the company’s future.

Beyond tea & coffee

TGB, which operates in 40 countries — tea and coffee categories account for 90% of its global sales — is eyeing a bigger role in the branded ‘good for you’ natural beverages segment. While tea and coffee will continue to be the company’s core business, water is being looked at as the third growth pillar given that the ₹4,200-crore organised bottled water market is growing at around 20% annually. As a move in that direction, TGB had acquired a majority stake in Mount Everest Mineral Water (MEMW), known for its premium water brand, Himalayan. To consolidate its distribution network, Bhat has taken the step of merging the company with TGB. The merger is expected to bring in more synergies in terms of distribution and reach, ensuring a faster break-even for the bottled water business.

Another major move by the company that will pay off in the long run is its equal stakes joint venture (JV) with PepsiCo, named Nourishco Beverages, aimed at the non-carbonated ready-to-drink beverage segment. The JV’s products, positioned on the health and wellness plank, are distributed via PepsiCo’s distribution in India and, of late, Nourishco is also helping push the Himalayan brand. The JV has successfully test marketed Tata Water Plus (packaged water fortified with zinc and copper) and Tata Gluco Plus (a flavoured beverage offering benefit of glucose energy, mineral salts and iron) in Tamil Nadu and Andhra Pradesh. These beverages will be launched nationally over the next 12 months. While Himalayan’s distribution in India is being increased, plans are afoot to take it to South East Asia. The management expects Nourishco’s product portfolio of natural beverages to expand in the coming years and expects the JV to achieve revenue of around ₹700 crore by 2016. 

Yet another kicker for growth will come from TGB’s hot and happening brew, the equal stakes joint venture with Starbucks Coffee Co. The JV seeks to spread the legendary Starbucks coffee experience by rolling out a chain of cafés across India over the coming years. The first café opened in October 2012 and new stores are being opened aggressively; currently, there are over 31 outlets across Mumbai, Delhi and Bengaluru. Café Coffee Day is currently the largest coffee chain in India positioned at the mass end, with over 1,500 outlets across 28 states and an estimated revenue of over ₹600 crore. Barista Lavazza and Costa Coffee are other smaller coffee chains with 170 and 110 outlets, respectively. Tata Starbucks cafés are positioned at the premium end and the JV has grand plans to expand to around 200-250 stores by FY16 and over 1,500 stores over the next decade. Taking cues from the performance of existing stores, it is estimated that a Tata Starbucks café should generate revenue of ₹2-2.5 crore a year. Starbucks has operating margins of around 21% and 35% in the US and China, respectively. The TGB management indicates that all Tata Starbucks stores are generating a cash profit despite their relatively short period of existence. Thus, we expect the business to generate 20-25% operating margin after achieving stability and a return on invested capital of 25%. We believe Tata Starbucks shall be one of the key value generators for TGB shareholders going ahead. Also, TGB subsidiary Tata Coffee shall gain from being the exclusive supplier to all Tata Starbucks stores and catering to the coffee needs of Starbucks’ business operations overseas.

Commodity tag

Inputs costs of TGB’s key raw materials — tea and coffee — are also softening significantly. Price of Arabica coffee has more than halved over the past two years and is lower by 27% y-o-y now and the price of Robusta coffee has declined 18% y-o-y. Bumper tea production in Kenya has led to a sharp fall of over 30% in the price of Kenyan tea. Consequently, the price of tea at Indian auctions is nearly flat. While decline in raw material prices augurs well as it results in better profitability, sales volume pressure in the tea and coffee businesses in Europe (especially UK) and the US (Eight O’Clock Coffee), respectively, have led to the company giving away savings in the form of a reduced selling price. Also, advertising and promotion investments have been stepped up to support existing and new launches. Thus, most savings from lower raw material cost will be used to support sales in weakening developed markets and boost profits marginally. 

I believe there are two levers that one needs to address for a re-rating of Tata Global. One is the commodity price multiple that it is discounted at despite possessing a suite of global and local brands. TGB undertook a slew of acquisitions over the past decade with the objective of becoming a global leader in natural beverages (particularly tea and coffee). Low profitability of these overseas businesses has led to return on equity being very low at 7-8%. I believe the newer asset-light businesses of Tata Starbucks and Nourishco, which promise high return on invested capital, have the potential to drive the consolidated return ratios of the company to a respectable double digit. The Starbucks JV will clearly nudge the valuation multiples higher and the Pepsi JV will, over the longer term, help monetise its product portfolio. Structurally, over 65% of its revenue is earned outside of India and a weak rupee will assist it in clocking higher margins. In our view, investors looking at a cheap FMCG play (which is a rarity) will find one in TGB. The stock currently trades at 19 times and 16 times consensus earnings estimates for FY14 and FY15, respectively. b

—The writer does not hold a position in the stock and Elara also has no coverage on the stock