Tata Coffee Limited May 31, 2018 Summary of rated instruments Previous Rated Current Rated Instrument Amount Amount Rating Action (Rs. crore) (Rs. crore) Commercial Paper 30.00 30.00 [ICRA]A1+; re-affirmed 65.00 [ICRA]AA (positive) / A1+; re- Fund-based-Bank Facilities 65.00 affirmed Total 95.00 95.00 *interchangeable between short term and long term Rating action ICRA has reaffirmed the long-term rating of [ICRA]AA (pronounced ICRA double A) and a short-term rating of [ICRA]A1+ for the Rs. 65-crore1 fund-based bank facilities, completely interchangeable between long term and short term, of Tata Coffee Limited (TCL)2. ICRA has reaffirmed the [ICRA]A1+ (pronounced ICRA A one plus) rating for the Rs. 30-crore Commercial Paper (CP) programme of TCL. The outlook on the long-term rating is Positive. Rating Rationale The ratings factor in TCL’s diversified nature of operations, with presence in roast and ground coffee, instant coffee and plantation coffee along with a geographically diversified revenue base. The ratings also favourably factor in the conservative capital structure and healthy debt coverage indicators of the company – both at standalone and consolidated levels. While the standalone gearing stood at 0.1 times as of end-FY2018, the consolidated gearing stood at 0.67 times. While the standalone Interest Cover stood at 5.47 times in FY2018, on a consolidated basis, it was stronger at ~7.24 times. A conservative capital structure along with the status of being a Tata Group company and a subsidiary of Tata Global Beverages Ltd. (TGBL, rated at [ICRA]AA+ / Stable / A1+) provides significant financial flexibility to the company. However, the above strengths are offset, to an extent, as the company’s coffee and tea businesses are exposed to agro-climatic conditions, notwithstanding the steps taken to reduce such risks. In addition, the commoditized nature of the instant- coffee business, which faces intense competition, and the sensitivity of operating margins to adverse movements in coffee prices, impacts the business risk profile of the company, notwithstanding the integrated nature of operations of the standalone entity. The financial performance of the company, particularly the standalone entity, witnessed deterioration in FY2018. This was on account of a combination of factors – lower coffee production due to adverse climatic conditions, softening of prices at the coffee terminals due to expectations of global oversupply, lower sale of the instant coffee division and the appreciation of the Indian rupee (INR) against the US dollar. At the standalone level, the operating income (OI) declined by ~ 10% to Rs. 691.78 crore. The operating profitability (OPM) declined from ~ 17.3% in FY2017 to ~ 5.9% in FY2018. On a consolidated basis, the decline in OI was much lower at ~2.3% as overseas revenues compensated the decline in standalone business to a large extent. While in the USD terms, overseas business grew by ~ 8.7%, appreciation of the INR resulted in growth 1 100 lakh = 1 crore = 10 million 2 For complete rating scale and definitions please refer to ICRA’s website www.icra.in or other ICRA Rating Publications 1 slowing down to ~ 4.4% in the INR terms. The consolidated OPM stood at ~16.1%. The consolidated net profit margin, however, was supported by a lower tax rate in the US. ICRA expects some of the factors that affected the company’s performance to reverse in the current year, resulting in an improvement in the financial performance of the standalone entity. However, the trend of softer coffee prices could continue to weigh on the performance of the standalone entity, limiting the expansion in operating profitability. The exact trend in prices, however, would be a function of the global supply-demand dynamics going forward. On the other hand, softer coffee prices are expected to result in an improved performance of Eight O’clock Coffee, which has already shown a relatively stable trend in FY2018 as full benefit of lower input prices accrues to the company. While reaffirming the ratings, ICRA also notes that the execution of the instant coffee project in Vietnam is on schedule. The 5,000-tpa freeze dried plant is expected to start production from Q4 FY2019. This is likely to further strengthen the operating profile of the consolidated entity over the long term. The total capital outlay for the project is estimated to be around Rs.350 crore, to be funded by a combination of equity and debt. While project execution risks along with risks associated with stabilization of the unit remain, ICRA takes comfort from the experience of the management and the established position of the company in the freeze-dried instant-coffee business. The extended period of debt repayment along with a sizeable moratorium period is also a credit positive. Rating Outlook: Positive The Positive outlook is underpinned by the expected improvement in TCL’s performance – both at the standalone and the consolidated levels in FY2019. In addition, TCL’s operating profile is likely to strengthen with the commissioning of the instant coffee plant in Vietnam towards the end of the current fiscal. The outlook may be revised to Stable if the extent of improvement in performance is muted. The outlook may be revised to Negative if there is a substantial deterioration in the operating environment of the company, including a sharp decline in coffee prices from the current levels, followed by a sustained period of low prices. Key rating drivers Credit strengths Diversified nature of operations, geographically diversified revenue base: TCL has a diversified revenue base with presence in roasted and ground (R&G) coffee, plantation coffee, instant coffee, tea and pepper. In FY2018, income from the US-based Eight O’clock Coffee (EOC) accounted for ~55% of the consolidated turnover of the company. EOC is an established player in the US R&G coffee market. Coffee, mainly in the form of green beans and instant coffee, is the primary driver of the standalone business, accounting for almost 75% of the operating income. Of the balance, tea and pepper are the largest contributors, accounting for ~15% of the standalone business in FY2018. Exports account for the major portion of the standalone income. While green coffee is exported primarily to the premium markets of Europe, instant coffee is exported to number of countries / geographies including Russia / CIS, the African continent and South East Asia. With the commissioning of the Vietnam project, the overall operating profile of the company is expected to strengthen further. Integrated nature of operations; focus on quality: At the standalone level, TCL is a fully-integrated coffee company with its own coffee plantations, curing factories, roasted and ground (R&G) coffee facility and instant coffee production plants. The integrated nature of its operations mitigates the adverse effects of volatile coffee prices. The company’s focus on selling high quality value added and differentiated coffee results in higher realisations compared to market/terminal prices. More than 90% of the company’s plantation coffee is exported, with a major portion to the premium markets of Europe. The company is also the exclusive supplier of superior quality Arabica beans, including the “Nullore Microlot”, to Tata Starbucks stores in India. In terms of revenue, the instant coffee division (ICD) remains the major contributor with a share of more than 50% to the standalone topline. The capacity utilisation level of the ICD has been healthy at more than 95% for the last few years. Sales of the ICD, however, witnessed a decline in FY2018 on account of lower volumes to a key 2 customer. In the tea segment, the company has increased its focus on producing better quality orthodox teas, share of which has shown an increasing trend in the overall tea volumes. Favourable financial risk profile: The capital structure of the company, both at the standalone as well as the consolidated levels, remains healthy with a gearing of 0.1 times and 0.67 times, respectively. While debt for the standalone entity only comprises working capital loans, consolidated debt includes term loans towards EOC business as well as the upcoming ICD in Vietnam. Coverage indicators for the company remained healthy in FY2018, notwithstanding a decline, with interest cover of ~ 5.47 times and at ~ 7.24 times for the standalone and consolidated entities, respectively. The term loans on the books of EOC as well as the loans contracted for the Vietnam project have an extended repayment schedule, thus supporting coverage indicators going forward. Moreover, a significant portion of EOC’s debt is from subsidiaries of TGBL. Credit challenges Susceptibility of plantation business to adverse agro-climatic conditions: The fortunes of the plantation businesses of coffee, tea and pepper remain exposed to agro-climatic risks, including incidents of pests. While TCL has worked extensively to mitigate the effects of such risks, including adequate irrigation facilities, adverse overall conditions impacted production, particularly the Robusta variety, in FY2018. As a result, the financial performance of the company was affected. Exposure to volatile coffee prices; commoditised nature of the instant coffee business: While the integrated nature of operations mitigates the adverse effects of volatile coffee prices, the overseas operation of TCL is exposed to fluctuation in coffee prices, primarily the Arabica variety, which is the primary raw material. Arabica prices have witnessed substantial volatility in the past which had affected the performance of EOC as it is primarily a price taker and follows the pricing strategy adopted by the market leaders. In FY2018, while Arabica prices have softened, the entire benefit of the same was not available to EOC due to higher prices of raw materials which were contracted earlier. At the standalone level too, TCL remains partially exposed to volatility in coffee prices.