McLeod Russel Continues to Divest Assam Estates

McLeod Russell Ltd. garden
There is no status quo for Assam’s tea industry. Signals of change are everywhere, mainly centered on financial restructuring. One of the most visible is McLeod Russel’s series of divestments of 14 of its 48 gardens in Assam. This is a flashing red light that multinationals do not see a path to profitable growth from advantages of scale in India’s commodity bulk black tea market. McLeod aims at shifting to packaged tea, with higher margins and more opportunity for differentiation. The formal approval from shareholders in the Williamson Magor Group (WMG), of which McLeod is part, to reduce assets was announced in May 2018. McLeod has approximately $140 million in long-term debt. WMG’s goal is to reduce this by at least half by the end of the current fiscal year. The latest proposal, in mid-September, is for the sale of two gardens to Goodricke, amounting to 4 million kilograms of capacity out of the McLeod total of 67. Two estates in Dooars in West Bengal were sold to Civil Engineers Enterprises. Four additional gardens in Assam were bought by Saffron Enclave, a non-tea firm. Between June and September, the company had divested 12 estates to MK Shah and Luxmi. The completion of the Goodricke deal will leave it with 49 milli-kilogram capacity. The reduction still leaves WMG as the world’s largest tea plantation grower (100 milli-kilograms). Much of this is financial engineering: reduce debt payments and balance sheet solidity, fund a buyback of shares and improve operating margins and cost flexibility. Both McCleod and WMG are reporting losses in recent quarters. More broadly, though, the sell-off reflects other “All Change” signals across the Assam landscape. The questions they raise don’t have clear answers. Some point to evolutionary innovations and impacts: the accelerating success, premium prices and government support for small grower specialty teas, for example. Others may be more interrelated and radical—even revolutionary—factors. These most obviously include the 2018 increases in estate worker wage rates, unionization, and mechanization. For McLeod, the financial moves support a major repositioning of business strategy. Several of the estates it has sold were ones it bought from Unilever Hindustan as recently as 2007, during its expansion surge. Scale was seen as the business leverage and plantation assets as the foundational building blocks. McLeod exited from its four Darjeeling holdings in 2001 because they did not provide volume. The assets now no longer provide leverage or command premium valuation. The May 2018 press coverage of McLeod’s plans uniformly quoted that it expected to be paid “at least” 400 Rupees per kilogram of production. The actual realizations have been in the range of 320-350 rupees per kilogram. The basic problem in Assam has been growing for many years: its reliance on CTC (cut, tear, curl) tea in a context of fierce international competition, a stagnant domestic market for basic black tea, unfavorable price trends, and ever higher production costs. CTC: Well over 90 percent of Assam’s tea production is for CTC, the granular, mechanized commodity black tea. Of the 850 large estates, only 150 make any Orthodox whole leaf. Two hundred 0f Assam’s total of 100,000 small growers account for close to half the Orthodox output. International competition: Assam has for long been the largest tea growing region in the world. Its traditional export markets, most obviously the UK, gave it a commanding position. Now, even though it produces 25 percent of the world’s output, it has just a 10 percent share of exports. Its premium teas command very high prices and have stellar reputations; its Orthodox and green teas in general sell for INRs250-500 ($3.50) per kilogram and CTC for $2 (INRs 130-140). Overproduction and lagging demand have built up an 80-million kilogram tea surplus stock. Stagnant markets: It’s no news that the growth markets for tea worldwide are marked by new flavors, variety, wellness, and lifestyle priorities, green tea, flavored teas, botanicals, matcha, millennials, bubble tea, customization, personalization, and technology innovation. None of these terms are dominant elements of Assam CTC bulk tea. Innovation in Assam is coming from specialty teas produced by small growers. The government and tea agencies are moving fast to strengthen this dynamic. The Guwahati Tea Auction center, which sells close to half of Assam’s production, has reduced the requirement for being listed in the catalog from 500 kilogram to just 1 kilogram. Tocklai, India’s widely-respected tea research center, has been tasked with a comprehensive training program for small growers. Production costs: Assam’s operating margins are too thin to sustain quality, social stability, and worker incomes. Even when revenues increase, profitability lags. The socially urgent decisions by the government to raise wages by just $0.45 (INRs30) per day and grant land title to thousands of small growers compound the equation. Wages, including benefits, are in effect a fixed cost that amounts to more than 40 percent of direct expenses and often higher. Productivity is low. Assam workers produce on average 2.5 kilograms per day, versus 6 in South India. Prices can rise and fall cyclically but over the longer secular cycle are flat. Costs are going up by 9 percent per year.
McLeod Russell Ltd. garden workers
The labor factor is part of McLeod’s incentive to sell off plantations and Goodricke’s reason for buying. McLeod’s labor costs are 45 percent and Goodricke’s 35 percent, with a more balanced mix of operations. McLeod states as a primary goal to rebalance its fixed asset base, increasing outsourcing, and entering joint ventures in tea packet production and distribution. It will rely more on bought leaf and is expanding its African sourcing. It seems certain to target mechanization to reduce labor costs. This move is key for McLeod to build a higher margin presence in India’s markets. McLeod is a bellwether. It clearly will be a different company five years from now in a different Assam industry in a different global identity. All these factors will play a role in the dynamics of change. It should come as no surprise that this oldest of Indian grower companies, dating back to 1869, should be looking to launch packaged teas on the world’s largest global e-commerce platforms, including Alibaba. The firm has already expanded its original target of $68.5 million (INRs5 billion) from asset sales to $110 million (INRs8 billion), freeing up more cash for diversity in growth. It is moving from the long-established multinationals’ business models; these have been asset-heavy, reliant on inhouse capabilities and creating value through production. The dominant direction across industries is towards asset-light, multi-sourced relationships along the logistics chain, and creating value through branding and marketing. Mcleod meets Alibaba… What next?