Why shun tea (agricultural) stocks?

In their otherwise excellent H2 research piece, D&B have advised investors to avoid tea stocks. This in itself is unusual because brokers (stocks salesmen), will rarely advice you not to buy any share, never mind a whole mini-sector. Their advice was based on changing tastes, fx issues and inflated production costs. Is this sound advice?

Investors will normally invest based on their expectations of capital gain (price performance) and income (dividends). Expectations will change depending on their perception of how price drivers are working. These will be earnings growth; cashflow generation; market share; dividend policy; management and company structure and share liquidity to name but a few. The key word is how in control the company is over all these drivers. In the tea and agriculture sector in general;

1. Earnings are impacted by weather, world prices (fx), GoK policy, changing tastes. All these are outside company control and volatile but are also easily discernable. Its thus possible to do speculative plays based on observed weather patterns, global supply of the particular product and so on
2. Market share: For most at the NSE, they are in world market and with the exception of Rea Vipingo have a small market share. So Rea Vipingo comes into play here provide (1) is working well
3. Cashflow generation: This is probably the most volatile part of earnings for agriculture stocks based on (1).
4. Dividend policy: Most at the NSE are foreign-owned thus give generous dividends (dividend yields by Kapchorua Tea and Rea Vipingo are among the highest) as a means of income repatriation. Again this makes them attractive speculative plays as discernable by price movement as they approach FY.
5. Share Liquidity: They are foreign-owned thus all have a small float that in some cases means virtually no trades for months (Limuru Tea 70% owned by Unilever has traded twice in the last year).

Bottomline: Invest for speculative plays and dividends.

Briefs: Athi River showed a strong H1 07 ; BAT half yr was up slightly on prior yr, but also issued a profit warning as Kenya catches up with the rest of the world and starts to ban smoking; Williamson Tea and subsidiary Kapchorua realised improved FY PBT but predicted lower numbers for this year.

Thursday's Budget & the NSE

As always, Kimunya's presentation was Raila-like, populist but please read the detail. Some of the bits that will likely impact the NSE in the coming year/s are: Govt direct participation in the NSE per paragraph 38. Following its failed OFD for 19% of KenGen and the fiasco that was Mumias (for the shareholders at least), GoK wants to be able to sell its stakes in various NSE listed shares in small blocks as opposed to doing a large block at a go. Sounds good in theory, but in an illiquid market like NSE, this will only be doable if its targeted i.e. the block is partially offered to institutional investors. The issue that is causing concern is where GoK may try to shore up a share price. Opinion here is that the first is ok with safeguards, but the 2nd is a no no. Repayment of NBK's npls owed by parastatals over the next 20 years. No doubt, this will increase its liquidity and allow it to lend more. The question here is the interest repayments. NBK has been accounting for interest on npl in its P&L, in which case any subsequent repayments would not go through the P&L, but this is only if it has done this for all its npls. Another ksh13bn remains to be cleared. GoK also announced that it will be selling more its stake in NBK. Increased recapitalisation requirements for financial institutions over the next 3 years: There are currently several banks that fall under the ksh1bn that will be required. CFC-but they are already in advanced merger talks with Stanbic-for 6 months? DTK-despite doing a rights issue in December, they may need to complete their merger with Habib Bank HFCK-they are in the midst of a rights issue to sort this out NIC- they announced a rights issue on Friday Within the unlisted banking sector, there is quite a few that again will most likely merge or seek help from their shareholders. More importantly, the insurance sector is also being required to recapitalise. Sin taxes were in effect again, but one suspects that the demand inelasticity for these products is such that only a big rise in the duty would dent the profitability of EABL and BAT. Construction-related stocks will benefit from allowances on low cost housing. Finally, happy papa's day to all the fathers out there!

BAT Profits down for FY06

Please find release. Final DPS was 12/=.