The current fiscal has seen a sharp increase in the prices of tea. The average price sold in north Indian auctions in the week ended 26 May was up by 31% over the year-ago period, while that in south India was up by 42.3%. That is a significant increase, one that should see profitability jump.

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Prices of tea are going up after a fall in production. Mint’s Ravi Ananthanarayanan says tea marketers will now face the dilemma of whether they should pass on the costs to consumers.

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This could change as the year progresses, but as of now, prices seem to be on a firm footing, driven by lower output and partly due to rising production costs, too. McLeod Russel India Ltd said after its March results, that its India business’ operating Ebitda in 2011-12 was affected, despite better realizations, because of a 8 per kilogram (kg) cost increase due to higher wages, fuel, and irrigation and fertilizer costs. It expects costs to increase by another 8 kg during 2012-13 due to wage revision, increase in input costs, and loss of output during April. Ebitda, or income before interest and taxes, depreciation and amortization is an indicator of a company’s profitability.

India is not the only country seeing a drop in output. The Tea Board of Kenya said the country’s tea production in the January-April period was down by 22.2%. Sri Lanka’s output during the same period was down by 4%, said the Sri Lanka Tea Board.

Tea plantation companies such as McLeod Russel and Jay Shree Tea and Industries Ltd will see realizations jump, but if output falls significantly then they may find their margins getting singed. Since fixed costs for tea companies tend to be high, a lower output may not allow them to take full benefit of higher realizations.

Moreover, they may need to buy tea leaves from smaller plantations to make up for a crop shortfall, which could further affect margins, and also increase their working capital requirement. The ideal scenario for Indian tea plantations would be one where international prices are rising, while domestic output remains stable or is rising.

Packet tea marketers such as Tata Global Beverages Ltd and Hindustan Unilever Ltd will find their procurement costs rise sharply. They will have to take a tough call on whether to pass on the cost increases in the domestic market, and risk the impact on demand, or absorb some of it and let margins take a hit. Tata Global will have a tougher time in hiking prices in developed markets, where large retailers oppose price increases as it affects consumer demand.

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