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Addictive growth for ITC

Source : BUSINESS_STANDARD
Last Updated: Mon, Jan 21, 2013 19:39 hrs
A man talk on his mobile phone as he walks past an ITC office building in Kolkata

Cigarette maker ITC has again delivered a robust set of numbers for the quarter ended December 31, 2012. The key highlights of the results were the strong performance of cigarette business as well as reducing losses of the fast-moving consumer goods (FMCG) business. The stock currently trades at 24.3 times FY14 estimated earnings and analysts believe these valuations should be sustainable over the medium term. Most analysts remain positive on the company given the consistent performance of its cigarette business (profit growth in high teens over the past six years), high return ratios, strong brand equity and pricing power.



Analysts expect ITC to deliver 22 per cent earnings growth over FY12-15 driven by strong margin expansion in the cigarette business and breakeven of the fast-growing FMCG business. "ITC's solid competitive positioning and consistency of cigarette earnings delivery should support premium valuations. We reiterate buy, with a modest target price increase to Rs 340. ITC remains our preferred consumer pick," says Jamshed Dadabhoy of Citigroup. Experts are ruling out any significant increase in excise duty in this year's Budget (given the steep hike last year) and believe any correction in the stock price prior to the Budget will provide a good entry point.

Small cigarettes:
The next big' thing

For the quarter ended December 2012, ITC beat Street estimates driven by strong growth in its cigarette business. Notably, cigarette volumes grew at one to two per cent for the quarter, pushing earnings before interest and tax (Ebit) margins of this segment to 21.1 per cent. Resilience of ITC's cigarette business can be assessed by the fact that despite a hike of 16 per cent in its average realisation for the nine months of this fiscal, volumes have grown.

Analysts also remain positive on the margin expansion story in this division. "ITC's Q3FY13 results further reinforce our conviction that Ebit growth trajectory of its cigarette business has increased to 20 per cent plus, compared to consensus estimates of 15 per cent as seen over FY02-12," says Anand Mour, FMCG analyst at ICICI Securities. Going forward, analysts expect ITC's cigarette volumes to be driven by increased traction in the small cigarettes (64 mm length) segment as consumers up trade from other tobacco products to cigarettes (given the low entry point as well as that 14 states have banned gutka and chewing tobacco products). This could push up the March 2013 quarter cigarette volume growth to six per cent and for FY13 to two per cent, say analysts.

STEADY GROWTH
In Rs crore Q3'FY13 FY13E FY14E
Net sales 7,627 29,274 34,605
Y-o-Y change (%) 23.1 18.0 18.2
Ebitda margin (%) 37.1 35.2 36.6
Y-o-Y change (bps) -80 100 140
Net profit 2,052 7,483 9,242
Y-o-Y change (%) 20.6 21.4 23.5
P/E (x) - 30.0 24.3
E: Estimates
Source: Analyst reports

While the company has successfully passed on (through price hikes) higher excise duty as well as VAT burden, implementation of ad-valorem duty structure (introduced in the last Budget and later withdrawn) remains a key risk as it can impact the company's profitability.

FMCG breakeven in FY14
ITC's FMCG segment has been posting a strong 20 per cent plus revenue growth for the past six to seven quarters. In the December quarter as well, this segment's revenue grew 30.1 per cent (on 15-18 per cent volume growth). All its categories, namely, biscuits, soaps and wheat flour have grown well in the quarter. The company hopes to witness pick-up in the shampoos segment on the back of recent re-launches. The Ebit losses from this segment have also narrowed to Rs 24 crore as against Rs 68 crore in the March 2011 quarter. A break-even in this segment would boost sentiments significantly, which analysts expect by early FY14.

Amongst other segments, agri-business surprised positively on revenues (up 43 per cent) as well as Ebit (up 21 per cent) growth - driven by wheat exports. On the other hand, hotels and paper business disappointed with muted Ebit performance. Higher input costs restricted Ebit growth of the paper business to a mere two per cent, while Ebit of the hotels business fell by a whopping 46 per cent. ITC's hotel business is likely to be under pressure in the near-term and continues to report lower return ratios due to the slowdown in tourist as well as business traveller segments and the company's continued investments in new properties. However, the opening of its Chennai property should provide some cushion to this segment.


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