Govt intervention in Colombo tea auction detrimental to sector: Fitch

tea

Nov 17, 2015 (LBO) – Sri Lanka’s government intervention into the Colombo tea auction will be detrimental to the sector as it will make Sri Lankan tea less competitive in a global market that is over-supplied, Fitch Ratings said.

The Sri Lankan government in October 2015 allocated 1.0 billion rupees to purchase tea at the Colombo auction to drive prices to LKR450/kg, a decision which has yet to be implemented.

The last time the government intervened to prop up tea prices was in 2008.

Fitch further said credit profiles of Sri Lanka’s listed tea plantation companies which derive more than 50 percent of the revenue from tea will continue to weaken amid depressed prices and high wages.

The combined leverage, calculated as net debt/EBITDA, of all listed Sri Lankan tea plantation companies has risen to 9.9x at end-September 2015 from 2.4x in 2013 as low prices and cost increases have significantly impaired the profitability and cash flow generation of the companies.

Fitch expects sector leverage to remain at high levels in the long term because of regular wage increases and low productivity compared with other leading tea exporting countries.

The average price at the September 2015 Colombo tea auction – where all plantation companies sell more than 90 percent of their production – fell to LKR370/kg, the lowest price since February 2012 largely due to lower demand from Sri Lanka’s key customers, including Turkey, Russia and the Middle East.

At the same time, labour costs, which form about 70 percent of tea plantation companies’ production costs, have risen 25-30 percent in the last few years, Fitch said.

As a result, the average EBITDA margin of listed tea companies has narrowed by more than 10 pp between 2013 and 1H15, with most of them posting operating losses so far in 2015.

The higher wages stem from the collective agreements between trade unions and plantation companies, which call for wage increases every two years.

“These increases have averaged 20 percent in the recent rounds, and they are not linked to productivity,” Fitch said.

“Each time the wage increases are enforced, sector margins narrow – a cycle that Fitch believes has become fixed in the cost structure of the sector.”

The ratings agency said ongoing negotiations for the 2015 wage increase are currently at a deadlock, with trade unions demanding a 60 percent increase while the companies are seeking a deferral till next year or a maximum increase of 10 percent given the low selling prices and their struggle to break even.

Current auction prices are hovering around LKR400/kg, which remain well below the average production cost of LKR450/kg, and any wage increase would undermine the profitability of the tea companies.