Production decline in key tea exporting countries: The tea production in the key tea exporting countries, such as Kenya and Sri Lanka, witnessed a drop of 22% year-on-year (y-o-y) and 7% y-o-y respectively over the period of January-April 2012. The drop in the tea production was largely on account of abnormal weather conditions in the key tea growing areas in both the countries.

Kenya witnessed a significant drop of 42% y-o-y in April 2012. On the other hand, India’s tea production was down by 10.5% y-o-y over January-April 2012. This widened the demand-supply gap for tea in the international market, as global consumption is growing in lower single digits per annum.

Tea prices have firmed up globally: The widening of the demand-supply gap has led to the firming up of the tea prices in the international market. The Kenyan and Sri Lankan tea are currently trading at a premium of Rs25-35 per kg at the respective auctions. Kenyan tea prices stood at around Rs 150 per kg in May 2012 as against Rs 118 per kg in May 2011.

Favourable scenario building up for domestic tea growers: The production shortfall in the international market has resulted in an increased demand for Indian tea in the international markets. The increase in the prices in the international markets, the good demand for Indian tea in the global markets and the production decline in the first four months of CY2012 have led to a spurt in the Indian tea prices in the recent past. The average price of Indian tea stood at Rs 138 per kg in May 2012 as against Rs 106 per kg in May 2011.

The good demand for the Indian tea in the international markets has improved the export realisation for tea planters in India. Also, an increase in the tea prices has improved the domestic realisation for the tea planters. This would result in an improvement in the profitability of the domestic tea planters (including companies like Mcleod Russel India Ltd [MRIL], Jayshree Tea and Warren Tea).

Maintain our bullish stance on MRIL: We expect MRIL’s top line and bottom line to grow at a compounded annual growth rate (CAGR) of 17% and 21% respectively over FY2012-14 on the back of a strong improvement in the average realisation. At the current market price the stock is trading at 9.2x its FY2013E earnings per share (EPS) of Rs 29.9 and 7.2x its FY2014E EPS of Rs 38.2.

In view of the favourable pricing environment building up for domestic tea planters, MRIL having the largest tea growing area under coverage and the discount in the valuation of the stock compared with its peers, we maintain our bullish stance on MRIL.

The recent news of tax litigation under the retrospective tax law might have a sentimental impact on the stock price in the near term. However, the company’s business fundamentals are intact and the stock is a good investment opportunity from the long-term perspective. We maintain our Buy recommendation on the stock with the price target of Rs 339.