Tata Global Beverages Ltd’s management has projected turnover to reach $5 billion (around Rs23,300 crore) by 2015 and profit before interest and tax margin to be around 15%. That’s a 32% compounded annual growth rate from its fiscal 2010 revenue of Rs5,870 crore and a 4 percentage points jump in its PBIT (profit before interest and tax) margin.

Holding other things constant and extrapolating this margin increase, earnings per share could work out to around Rs40 and price-earnings multiple, based on 2015 earnings, will be just three times. It could explain why its share price rose by 5% on Monday.

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Over the years, Tata Global, formerly Tata Tea Ltd, has reshaped itself with a global outlook, starting with its transformational Tetley acquisition. A few more acquisitions helped fill portfolio and geographical gaps.

While it has grown in size over the years, its pace could have been faster. A few external factors have affected its trajectory. Its major markets are in the developed world, where the economic slowdown has affected operations. In these markets and increasingly in others, too, organized retailers dominate the trade. They refuse price increases when tea prices go up and insist on price cuts when raw materials become cheaper. Lack of pricing power has become a key limiting factor.

A more macro-development is a gradual decline in black tea consumption, with preference shifting to others such as green and flavoured teas. Companies such as Tata Global are wrestling with these challenges. Despite having a branded business, it is unable to insulate itself from the underlying commodity cycle.

What it has been doing is to gain share in key markets, and use the resultant scale and operational changes to become more cost-efficient. But that’s not enough. It is testing new products including enhanced water (added with vitamins, etc.) and it acquired a mineral water company, too. It is planning disruptive innovation in beverages and may even enter the foods business, but will probably focus on niche health and nutrition segments. Being present in emerging consumer segments could give it better pricing power.

But investor reaction appears premature as it has not outlined any categories yet. And the size of its projected turnover indicates that acquisitions will be large. Large and fast-growing businesses don’t come cheap, so funding should be a key concern.

The firm has cash of around Rs1,900 crore and investments with a market to net asset value of around Rs800 crore. Its debt to equity ratio is 0.5:1. A large acquisition may require it to raise more debt and equity, thereby affecting its capital structure. Investors should consider how that could affect interest costs and earnings per share before they jump to conclusions.

Graphic by Ahmed Raza Khan/Mint

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