There’s a today/tomorrow distinction in any business’ financial operations. Today centers on revenues, cost management, and productivity — getting the most out of the resources available now. Tomorrow is about investments that can improve all of the above. The variables in the financial funding equations are cash flow from operations plus capital from investors, lenders, and grantors. For too many tea producers, regions, and even countries, the coefficients here are not positive: Weak cash flow-generation and eroding profitability, reduction in access to bank credit, and, even for large, well-established players, a weakening of asset base.
To pick one example of each that indicates a more general pattern: (1) Profits: even before the pandemic, Sri Lanka’s tea growers had seen an accelerating weakness with flat revenues and declining production; at the end of 2019, only 3 of 14 public tea estates reported a profit; (2) Loan interest: in Rwanda, whose tea industry has been expanding and where government support has been strong, interest rates doubled from 2012 (8%) to 2014 (15%); and (3) Large firm’s collapse: Arpeejay, Indian’s third-largest tea producer joined the largest plantation owner, Russel McCleod, in reporting large liquidity problems in 2019 and a consequent inability to service its debt. McLeod had sold off 11 tea gardens. Duncans’ debt problems had led to bankruptcy and government takeover of half its 14 tea gardens in 2016.
Cash is king
Cash flow from operations is the core problem for growers and processors today. The financial stresses facing them are widely tracked and reported, with less and less good news.
The overall realities of the tea industry are analogous to tightrope-walking across a windy chasm; many will slip and fall off. Global overcapacity, price volatility, seasonality, labor shortages and wage costs, energy and water supply, land degradation, drought and shift in rain patterns all compound unpredictability and instability. The trends are increasingly negative, with only occasional blips of growth. The pandemic adds massive new stresses and changes the dynamics of every factor affecting supply, demand, and production. No one can reliably forecast medium- and long-term impacts.
Most of the reporting focus is thus on seasonal and annual operating profitability, this year’s tightrope walk. The measure of health here is free cash flow (FCF): the funds available for distribution to owners, repayment of debt and, most key, investments that directly improve operations, productivity, trade, and sustainability. FCF is not the same as profit, which is affected by many non-accounting deductions, like depreciation, accruals, and deferrals. NFL teams are experts in reporting an accounting loss while piling up the real money that drives up their value, but tea production is very much a cash-crop business. In many instances, there’s a gap between sale and cash — payments from sales and auctions, trade finance of exports, and purchase of seeds and fertilizer in advance of harvesting and revenue.
There’s an even deeper problem that seems likely to change the structures of the industry: the cost and availability of longer-term financial capital. The dilemma is that most of the methods, technology, and bio-management that helps improve revenues and operating costs demands funding that does not provide immediate returns and that is unaffordable for most producers.
A relatively few firms at the retail and service end of the value chain can attract angel investors or acqusition by large companies with strong financing capacity. Startups like Chai Point in India raise capital — $33 million in this instance — from private investors.
Most tea companies must finance growth from debt. Around 2010, this was fairly easy to get. The tea industry was on a track of continued growth of 4-7% a year. New markets opened up, especially among Asia’s increasingly affluent and trend-seeking millennials. The wellness market was beginning to surge, with herbal and green teas expanding variety and quality. There was a potential cornucopia of new products such as bubble and cheese tea. It wasn’t a rosy scene but a fairly robust one, and most commentaries as late as 2018 focused on the positives, especially at the consumer end of the value chain.
Loan interest rates reflected confidence. In 2011, for instance, the interest rate on government agency loans to Sri Lankan tea farms and factories was below 10%. In 2017, it was over 15%. In 2019, 15 factories that had been supported had closed; 30 were classified as NPL — non-performing loans — whose repayments were put off for 1-2 years.
In Rwanda, whose tea industry has been expanding and where government support has been strong, interest rates doubled from 2012 (8%) to 2014 (15%). In 2010, the National Agricultural Board encouraged tea farmers’ cooperatives to take on heavy loans from the Development Bank of Rwanda to invest in processing factories and increase production, with debt. The debt would be repaid from the resulting crop revenues. These did not materialize, with droughts and floods adding to export competition and price erosion. By late 2019, farmers organized appeals to wave the loans.
One cooperative illustrates the scale of the problem. Its thousand smallholders owe $3 million, of which $1 million is accrued unpaid interest. The cooperative only paid off $100,000 of the principal and the total is expected to accrue to $8 million. The original interest rate of 8% is now 16%. Other borrowers are paying 19%.
Many of these problems relate to the pandemic that has hit every tea growing nation, but they also reflect longer-term structural issues. Climate change has led to volatility and uncertainty on crop production volumes, and the gap between supply and demand has had the same effect on prices.
In Assam, operating costs grew by 7-10% a year but prices only by 1%. Industry associations have asked for major subsidies on debt and long-term financing to offset their erosion of margins. Representatives from Pakistan’s farmers met in August 2020 with senior government officials to “demand” interest-loan loans. They highlighted agriculture as the mainstay of the economy, efforts to diversify into cash crops and the rising costs of seeds and pesticides. They proposed that $300 million be set aside for the betterment of farmers.
However sympathetic one may be, it seems totally unrealizable. The government must raise the funds — in effect, borrowing to enable lending. Pakistan’s bond yield at this time was over 9% and rated as a weak B- with a predict 10% probability of default within the next few years. If farmers are not generating profits today, and there are no positive signs of major market shifts, how will they be able to repay the debt? How can a strapped government absorb the losses?
One key element of short-term capital covers the gap between production, sale, and receipt of payment from the contractor, auction buyer, wholesaler distributor, or other party in the supply chain. The key players here have long been private banks in handling the domestic elements and various types of agencies in providing trade finance and acting as guarantors. In India, small farmers are unable to obtain any bank loans to buy seed and fertilizers. Private money lenders that charged 25-35% on the typical $2,000 financing now demand 50-60%.
The gap between oversupply and lagging demand makes it increasingly hard for Indian producers to obtain any bank funding. The Economic Times newspaper headlined the situation in Darjeeling (May 7, 2018) as “Fund-starved Darjeeling tea companies face an existential crisis.” Ratings of many firms had dropped from A (good though not the best AAA) to BBB, which “makes it difficult to get working capital from the banks.” Banks cut off loans except to A-rated producers and imposed tight limits even on these.
Since then, the situation in Darjeeling worsened greatly: escalating costs, massive crop loss from political strife, a surge of legal and illegal increase in teas, competitive teas from Nepal, and soil erosion and underinvestment in bush renewal. The State Bank of India’s general manager commented that “We consider the rating changes while lending, but more than, that we follow a cash-flow-based financing policy.”
The cash flow isn’t there. Even if it were, time is not on the side of most players in most countries. There can be a long gap between investment and payoff. One obvious instance is the shift to organic farming. This typically reduces yields for four years. The many tools of precision agriculture are outlays that start generating value quickly but still demand money not tied up in today’s operations.
Drones that handle core functions of aerial surveys, light spraying, crop monitoring, tracking of water levels, weed growth, etc., cost as low as $1,800. Ones with multi-device and extra payload capabilities are in the $15,000 range. Maintenance, training, and other costs add up for the more complex systems and can be as high as 25% of the capital costs per annum. The benefits can be spectacular: up to 90% reductions in spraying and weeding costs: Water savings of up to 90%, chemicals reduced 30-50%. But the investment must be paid in advance of the payoffs.
Social impact and social development bonds rather than loans have been a source of large infrastructure funding. These aim at attracting a diversity of investors who take a long-term view. Kenya’s Gura hydroelectric project, led by the Tea Development Agency, attracted financing through the international Clean Development Mechanism. This is a complex scheme sponsored through the Kyoto Protocol where industrialized countries purchase saleable credits for projects that reduce emissions in developing economies. Initiated in 2005, the impact and future of CDM is hard to evaluate.
Energy and water costs are a growing burden on producers. Here, the capital investment is in infrastructures that serve many parties across a region. Historically, agencies such as The World Bank have spearheaded and underwritten the costs. Less than a decade ago, its total budget for loans to remediate climate change was $2.4 billion (2011). It doubled in 2012 to $4.6 bn. Another doubling in a year was announced at the end of 2018: to $200 bn globally for 2021-2025. Here again, there is a gap between investment and return. Hydroelectric plants can take a decade or more to build.
This is a bleak picture and it is made bleaker by all the disruptions and uncertainties created by the pandemic. That seems certain to constrain the ability of governments in many tea growing nations to raise and commit funds to loans, subsidies, trade financing and infrastructure building. That applies, of course, to many industries.
Every capital-intensive opportunity must come with a capital-funding solution. That is the unmet challenge for tea.