Industry Risk Score : Coffee Industry

Executive Summary

 

Coffee is the second largest traded commodity in the world. It is largely produced in developing countries and consumed in developed countries.

India is the sixth largest producer and fifth largest exporter of coffee in the world. In 2017-18 crop season year, India is estimated to have produced about 3.3% of the global production. Cultivation of coffee in India is largely concentrated in southern states viz. Karnataka, Tamil Nadu and Kerala. India is largely known to produce two types of coffee – Robusta and Arabica. Indian coffee is distinct as it’s the only coffee that is grown in shade and it is grown with spices like cinnamon, cardamom, clove and nutmeg to give it an aroma.

The outlook of the coffee industry in India looks positive. With the worldwide shortage of supply of coffee, the Indian exports are thriving in spite of trade barriers placed on Indian exports by some countries. The exports from India face competition from, Vietnam and Indonesia. The domestic consumption of coffee is also increasing with younger generation gravitating towards coffee and with coffee cafes becoming a popular hangout. The domestic market is dominated by a few large players such as Nescafe, Hindustan Unilever and Tate Tea. There are few brands that don’t have presence pan India but are very popular in the local market such as Leo and Narasu’s.

The harvest of coffee has been erratic, despite production increasing steadily over the years. There are a number of challenges that the coffee plantations face such as availability of labourers, inefficient small farms, dependence on climatic conditions, and threat to crop from pests. The government needs to take concrete steps to promote coffee exports. The GST on coffee is much higher as compared to tea. Research & Development activities are required to produce newer varieties of coffee, increase yield per hectare to reduce cost of production.



Key Risks & Attributes

  • Non-tariff barriers placed on exports by USA, European Union and Japan
  • Stiff competition with South Asian countries for export
  • Fewer coffee brands dominate the market
  • Inadequate supply of skilled labour
  • Production dependence on climate
  • R&D activities required to produce new coffee and reduce cost of production

Demand & Supply Scenario

5/6

Of the total coffee produced in India, around 75% is exported and balance is consumed in India. The demand for coffee has been increasing across the globe and is expected to remain robust. The demand for coffee has been increasing steadily over the years. With children as young as 18 years drinking coffee every day, it is slowly becoming a part of the culture worldwide. Some of the emerging economies are embracing this trend as well, and the demand for coffee is booming. On the other hand, the supply of coffee has been erratic due to climatic changes and in the last few years there has been shortage in its supply.

In FY2016-17, India exported 355,537 MT (Metric Tonne) of coffee to over 50 countries. Top 5 export destinations included Italy, Germany, Russian Federation, Belgium, and Turkey. United States is a major importer of coffee but it has put in place various non-tariff barriers on exports from India which restricted its volume of coffee exports. European Union and Japan also have similar tariff barriers placed on exports from India. Emerging markets are expected to drive global coffee consumption growth over the medium term as per capita consumption is currently low currently. Also, growth in traditional markets is expected to improve driven by the improved economic growth outlook.

The domestic demand for coffee stems from the retail market and coffee cafes. The local consumption of coffee has increased at 5% since 2010 due to various factors viz. younger population, increase in disposable income, influence of western culture, among others. There is an increase in knowledge about the variety, quality and origin of coffee.

Retail market consists of Instant coffee, Filter coffee, Ready-to-Drink mixes and Bean to Cup market. Filter coffee is largely popular in Southern India, while Instant coffee is sold all over India. The market for Ready-to-Drink mixes such as Instant Cappuccino is still at its nascent stage. Bean to cup market refers to the vending machines operated at most of the commercial establishments. The coffee roasting machines are being bought for use at home as well. Further, coffee flavor is gaining popularity in cold beverage segment as well as desserts.

Coffee cafes are gaining popularity in India. Its market is essentially the youth who consider it to be a fashion statement. The organised café market is estimated to grow up to Rs.1,5100 crores by 2020 at a Compounded Annual Growth Rate of 15%. At present, the cafes are concentrated in Tier 1 cities of India but with progression of Tier 2 and Tier 3 cities, the café chains are now expanding their footprints in these cities as well.

As regards exports, though there is sufficient demand, but volume of trade is dependent on factors other than commercial, which Acuité believes restricts the market for exporters. As regards local consumption, Acuité is of the opinion that the demand for coffee is increasing at a steady rate, and there is still a huge potential for the market to grow further.



Nature & Extent of Competition

4/6

The coffee exports will continue to be robust, but they can increase manifold if trade treaties can be entered with coffee importing countries. As regards the domestic market, though there are quite a few players in the market, each player has his own niche market.

The coffee export market is highly competitive. Indian coffee has to essentially compete with Indonesia, and Vietnam. But with robust global demand for coffee, both for Arabica and Robusta, there is no threat to the exports in the near future.

Further, exporting countries attempt to enter into trading agreements with importing countries to promote their exports. For instance, Belgium is a leading exporter of coffee to US because of North American Free Trade Agreement. Several steps are being taken in India to promote exports such as obtaining sustainability certificate from international bodies for coffee cultivated here, production of specialty coffee which is considered to be superior to normal coffees.

As regards retail coffee in India, Hindustan Unilever, Nescafe and Tata Tea are the most popular brands and dominate the coffee market. There are some regional brands which are essentially popular in specific states such as Narasu’s in Tamil Nadu and Karnataka, Leo in Tamil Nadu. Some imported brands are also available in the Indian market including Davidoff, Lavazza, Illy to name a few. They are marketed as luxury brands and cater to a different market segment than the Indian retailers.

Café coffee Day is the most popular coffee chain with over 1500 outlets all over India. The other known players in the organised café coffee chain market, both Indian and foreign, are Indian Coffee House, Barista, Starbucks and Costa Coffee. Further, there are many bakery and coffee chains that have mushroomed all over India, including tier 1 and tier 2 cities, serving snacks and freshly brewed coffee.

Acuité believes that since the export market is highly competitive, and therefore to get an edge, exporters need to constantly introduce newer varieties of coffee and get sustainability certificates. The Indian market is monopolistic as it is dominated by few players and each player sells differentiated product to carve a niche in the market.



Input Related Risk

3/6

There are a number of challenges that the coffee plantations face such as availability of labour, inefficiencies on account of small size of the farms, high dependence on climatic conditions and threat to crop from pests. They have been discussed in detail below:

  1. Over 90% of the coffee plantations consists of small farms which have area of less than 10 hectares. These small farms deal with problems including low crop yield per hectare, limited short term liquidity, restricted market access and inadequate technological assistance.
  2. The coffee yield is dependent on climatic conditions of temperature and humidity. Over the years, climatic changes such as rise in temperature and erratic rainfalls have had an effect on coffee production. In FY 2016-17, the production of coffee decreased as compared to year before that, due to deficit rainfall.
  3. Further, rise in temperature also allows various pests to survive which earlier did not survive in colder climate. These pests are a threat to the production of coffee.

Due to the above factors, coffee production has been erratic, but there has not been an overall steep fall or increase in production. An erratic production leads to price fluctuations.

  1. Labour availability – Coffee picking is a labour intensive work. It is becoming increasingly challenging to find sufficient labourers due to (1) seasonal nature of the work which necessitates labourers to find alternate ways to earn when not employed at the farms. (2) Wages are linked to the quantum of coffee picked, which means that the labourers need to work on the coffee slopes for a great number of hours to earn their daily wages. Since cost of labourers accounts for a substantial cost of coffee production, any increase in wages increases the cost of coffee.

Acuité is of the opinion that input related risks are steered by the Indian demographic spread and labour availability, which, in the short to medium run, will continue as key input risk.



Regulatory Risk

4/6

100% FDI is currently allowed in India’s coffee plantation through the automatic route with an aim to infuse fresh capital and technology into the industry and boost coffee exports. With regards to its trade, as mentioned above there are non-tariff barriers and tariff barriers imposed by some countries on imports from India that effect the demand for its exports. On the other hand the import duty on coffee has been pegged at 100% to discourage competition from imported coffee.

At the local front, even though Goods & Service Tax (GST) on non-roasted coffee beans is 0%, where as it is 5% on processed coffee. GST on instant coffee is pegged at 28% in comparison to 5% on Tea, however, this has not influenced the demand for coffee in India.

Acuité believes that coffee exports will get a boost if non-tariff barriers and tariff barriers placed on coffee exports from India are eased by the countries. Steps should be taken to enter into trade agreements with them to promote our exports.


Technology Risk

4/6

Given that most of the coffee producing farms are small and not self-sustaining, it is important to improve yield of coffee per hectare, ways of irrigation, among others to reduce cost of production. Constant innovation is required to produce newer types of coffee to be able to attract more consumers.

The government has set up Central Coffee Research Institute, which is entrusted with undertaking research activities for the benefit of coffee producers. They study various aspects of coffee production such as standardised soil management, usage of fertilizers, crop improvement, post-harvest technology, among others. They also train coffee producers not only from India but outside India as well to help them incorporate newer developments in coffee production.

Acuité is of the opinion that the research will help producers including the small plantations overcome their challenges in a more efficient manner.



Operating Margin

1/6

The Operating Margin of the industry for FY 2016-17 has reduced significantly from the previous year, and the median Operating Margin stood at 1.79% in FY 2016-17.



Interest Coverage

4/6

The interest coverage of the industry improved significantly from the previous years. The median Interest Coverage for FY 2016-17 was 1.96 times as against 1.40 times in FY 2015-16.



Return on Capital Employed

1/6

The median ROCE for the industry remained low but improved as compared to the previous year and stood at 2.76% in FY 2016-17.

Debt / Equity

5/6

The industry had a median gearing of 1.20 times in FY 2016-17.



GCA Days

3/6

The median Gross Current Assets stood at 233 days with an average of 218 days for the three-year period of FY 2014-15 to FY 2016-17.



Industry Financials and Industry Average

Fact Sheet (As on Year Ended March 31st)SUM Unit 201703 201603 201503
Net Sales Rs. Cr. 20,985 11,798 10,647
OPBDIT (Excl. NOI) Rs. Cr 166 212 146
Depreciation Rs. Cr. 95 90 87
PAT Rs. Cr. 236 (65) 52
Net Cash Accruals Rs. Cr. 331 26 139
Networth Rs. Cr. 1,468 1,136 1,190
Total Debt Rs. Cr. 2,858 3,020 2,386


Average Unit 201703 201603 201503
EBITDA Margin % 1.8 3.2 4.5
PAT Margin % 1.6 1.1 2.3
ROCE % 2.8 1.3 2.9
Interest Coverage Times 2.0 1.4 1.6
Debt to Equity Times 1.2 1.5 1.2
Debt to EBITDA Times 3.5 3.2 3.4
GCA Days Days 233 217 203


IRS Definitions

Acuité Industry Risk Scores are assigned on a six-point scale, with 1 indicating ‘High Risk’ and 6 indicating ‘Highest Safety’. The intermediate scores are defined in the table below:

Industry Risk Score Risk classification of the Industry
ACUITE IRS 1 Highly Unfavourable
ACUITE IRS 2 Unfavourable
ACUITE IRS 3 Neutral
ACUITE IRS 4 Marginally Favourable
ACUITE IRS 5 Favourable
ACUITE IRS 6 Highly Favourable


Disclaimer:

Acuité IRS should not be treated as a recommendation or opinion that is intended to substitute for a financial adviser's or investor's independent assessment of whether to buy, sell or hold any security of any entity forming part of the industry. Acuité IRS is based on the publicly available data and information and obtained from sources we consider reliable. Although reasonable care has been taken to ensure that the data and information is true, Acuité, in particular, makes no representation or warranty, expressed or implied with respect to the adequacy, accuracy or completeness of the information relied upon. Acuité is not responsible for any errors or omissions and especially states that it has no financial liability whatsoever for any direct, indirect or consequential loss of any kind arising from the use of Acuité IRS.

Our exciting journey started in 2005 with rating of bank borrowers most of whom were small and medium enterprises. At that time, credit rating was a concept known only to large issuers of capital market instruments. Since then, like a caterpillar transforms itself into a beautiful butterfly, we transformed to rate bonds, bank facilities of large corporates and issuers across industries. Along came many achievements - SEBI Registration in 2011, RBI accreditation in 2012, 50,000 ratings in 2018, 5,000 Bond and Bank Loan Ratings in 2017, launch of India's first Android and iPhone app to disseminate rating, tamper-proof QR-code-enabled rating rationales, and SMERA Terminal to name a few.

Now is the time to re-emphasize our increasing footprint across all segments of ratings through the launch of our new name - 'Acuité'.

The name has changed. The spirit of upholding highest standards of analytical rigour, continuous improvement, excellence in our processes and quest for innovation remains the same. We would like to re-emphasize that we will continue to work hard to provide independent, unbiased and timely opinion of highest standard.

Acuité means 'sharpness and clarity of thought and vision'. Let our research and ratings help you take decisions with confidence.


Sankar Chakraborti
CEO