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Reduce debt levels

Kamal K. Baheti     June 3, 2013
The tea business is cyclical in nature. In the past decade, we have seen both the best and worst of times. Some smart steps taken by McLeod Russel in the past three years have resulted in a healthy balance sheet, growth in bottom line and spreading of risks associated with the tea industry.

For a tea plantation company, acquisitions are the most promising way to grow. Since the turnaround of the tea industry from 2006, we found out that valuations of tea gardens have become steep in India. Also, the biggest risk for the industry is weather, which is beyond our control. Earlier, we were dependent on one locality (Assam). So we decided to extend geographies and acquired three companies in Uganda, Vietnam and Rwanda between 2009 and 2011. Today, these acquisitions account for roughly one-fourth - 24 million kilograms out of 102 million kg of total annual production. We would like to expand it further to around 50 million kg in four years.

In recent years, we have been trying to minimise the risk of tea price fluctuation. In case of our own plantation, the cost structure is fixed. So any fall in prices hits the profit margin instantly because we can't reduce costs in the same fashion. We have decided to tackle this challenge by going beyond our own plantations. Out of 1.1 billion kg of tea production in India, nearly 300 million kg comes from small growers. In the periphery of our 54 tea gardens, there are a large number of small growers. We are buying leaves from them. It is a big shift for us as we are no longer dependent only on tea prices. In the bought-leaf segment, costs are variable as leaf prices change in line with selling prices. We have a steady margin of 20 per cent in this segment.

The numbers
#Revenue: Rs 1,445 crore, up 14%
#EBITDA: Rs 381 crore, up 26%
#Net Profit: Rs 288 crore, up 17%
#ROE: 26.9%
(Figures for 2011/12; Source: Annual Reports)

#Largest integrated bulk tea company in the world with annual output of 70 million kg
#Dividend payout of 34.65% in 2011/12
#Debt-to-equity ratio improved from 0.85 in 2007/08 to 0.13 in 2011/12
#EBITDA margin improved from 17% in 2007/08 to 26% in 2011/12

All these steps have helped the company reduce its debt levels significantly while increasing the asset portfolio. Today, our gross debt stands at Rs 240 crore, including around Rs 160 crore of working capital debt. Being a tea company, requirement of working capital is seasonal for us. Our net debt is much lower at Rs 40 crore. That's because we have Rs 170 crore of tax-effective deposits with NABARD and some cash reserves. The debt-to-equity ratio stands at 0.15, which is much lower than 1.1 in 2004. The NABARD deposit can be used for capital expenditure plans of factories and plantation for the next four to five years.

For McLeod Russel, the journey began in 2004 when we got demerged with Eveready Industries India Ltd. At that time, we had annual tea production of 40 million kg and gross debt of Rs 270 crore. It was the time when tea industry was going through a difficult phase. The total cost per kilogram of manufacturing tea was higher than the selling price. In our professional courses we learnt that when the selling price is lower than marginal costs, the asset valuation is cheapest. So we went ahead and acquired Williamson Tea in 2005. It was a leveraged buyout. We took another Rs 200 crore of debt and added 19 million kg to total production. In 2006, when there was the first sign of turnaround in the market, profitability returned to tea companies. Within a year of the takeover, we reduced the debt by Rs 140 crore through a mix of internal generation and qualified institutional placement of $20 million. Since then, there's no looking back.

Kamal K. Baheti is wholetime director and CFO of McLeod Russell. He has been adjudged Best CFO in the category - Remarkable Leverage Management (medium).

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