Tata Tea: Quenching thirst
Business Standard — August 9, 2006

With the growth in tea market worldwide not anything to write home about, Tata Tea's testing of waters with a stake in Energy Brands Inc (EBI), which makes enhanced waters, couldn't have been better timed. The move is evidence of the company's intention to diversify into non-carbonated and non-alcoholic, ready-to-drink beverages which can only help grow the business at a faster pace and puts it into an altogether new league.

The acquisition of 30 per cent stake in EBI together with Tata Sons will give it access to brands [like] the mother brand Glaceau and sub-brands in a fast growing segment. Moreover, the company will gain control over the distribution in 40 states of the US where EBI is the market leader. Of course, the option to sell Glaceau and other brands in markets where Tata Tea has distribution presence, is always available. In other words, Tata Tea will help manage the growth of Glaceau which hopes to grow at 70 per cent compounded annually, over three to five years, creating an enterprise value of $10 billion compared with $2.2 billion at present.

In the last three years, Glaceau has grown at a CAGR of 200 per cent. At over six times trailing sales $355 million or at around three times current sales (CY06), the bill at $677 million is a tad expensive. Moreover, the interest burden will be heavy since the deal is to be funded by debt of around $400 million. Thus, it will take time for Tata Tea to digest the deal and in the immediate term an earnings fall of around 15 per cent cannot be ruled out. However, the stock should get re-rated from here on, given its size, global presence and product mix.

Traditionally, the stock has traded at an average P/E of around 12 times, which could move up to 15 times. The valuation at Rs 830 of 12 times FY08 expected earnings (prior to the acquisition) appears to be undemanding from a longer-term perspective.