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ITC posted a strong set of numbers for 2QFY2011 which were in line with
expectations. We estimate cigarette volumes declined ~1-2% for the quarter
albeit a sequential up-tick in volumes. Other key highlights of the results include –
1) double-digit sales and EBIT growth in cigarettes, 2) reduction in
non-cigarette FMCG business losses both yoy and qoq, and 3) 294bp margin
expansion in paperboards. We maintain Neutral view on the stock.
All segments deliver; earnings growth boosted by other income: ITC declared a
steady top-line growth of 16.3% yoy to `5,061cr aided by a 15% growth in
cigarette gross revenues (estimated decline ~1-2% in volumes, growth driven by
~15% price hikes) coupled with strong growth of 22% yoy in both agri-business
and non-cigarette FMCG business. Earnings grew by a robust 23.5% yoy to
`1,247cr largely on account of steady top-line growth, 44bp yoy decline in tax
rate and 74% yoy jump in other income to `211cr. Operating margin remained
flat for the quarter at 35.3% as savings in staff costs (down 40bp yoy) was offset
by 45bp jump in other expenses.
its ability to generate and invest strong cash flows in high potential businesses.
However, at the CMP of `171, the stock is trading at 23.3x FY2012E earnings,
i.e. at the upper cap of its historical valuation band. Hence, we retain our Neutral
rating on the stock, with a Fair Value of `177 based on our SOTP model.
Broad-based growth, all segments deliver high double-digit growth
ITC declared a steady top-line growth of 16.3% yoy to `5,061cr (`4,352cr). The
cigarette division registered 15% growth in gross revenues (12.9% yoy growth in net
revenues) on the back of better realisation (price hike of ~15%) and improved
product mix. In terms of volumes, we expect ITC registered a ~1-2% decline in
volume for the quarter indicating improvement in sequential terms.
Amongst other segments, the agri and non-cigarette FMCG business posted strong
growth of 21.5% and 22% yoy respectively, while hotels and paperboards registered
a modest 20.6% and 16.8% yoy growth, respectively.
Earnings grow strong 24% yoy partially aided by other income
Earnings grew by a robust 23.5% yoy to `1,247cr (`1,010cr) largely on account of
steady top-line growth, 44bp yoy decline in tax rate and 74% yoy jump in other
income to `211cr (`121cr). Operating margin remained flat for the quarter at 35.3%
as savings in staff costs (down 40bp yoy) was offset by the 45bp jump in other
expenses. In terms of segmental margins, cigarettes posted 40bp expansion (driven
by price hikes), non-cigarette FMCG business posted reduction in losses both yoy
and qoq in range of ~`18-22cr and paperboards margins expanded 294bp yoy.
However, higher contribution of agri-business to top-line coupled with 74bp margin
contraction in agri-business dragged overall margins.
Cigarette segment registered double-digit sales and EBIT growth
ITC’s cigarette division, for the quarter, registered 15% growth in gross revenues
(12.9% yoy growth in net revenues) on the back of ~15% weighted average price
hikes taken across portfolio post the excise duty hike of ~17%. In terms of volume,
we expect ITC registered ~1-2% decline for the quarter albeit indicative of a
sequential pick up in volumes and in line with our expectations. EBIT margins
expanded 39bp to 30.3% aided by price hikes driving a steady 16.5% growth in
EBIT. We believe the cigarette business is well poised to post double-digit revenue
and EBIT growth in FY2011E. We have modeled in a 1.4% growth in cigarette
volumes for FY2011 (likely to be back-ended in 2HFY2011E).
Non-cigarette FMCG on steady growth path
ITC’s non-cigarette FMCG business registered a steady revenue growth to 22% yoy to
`1,057cr (`865cr) driven by impressive performance from its branded packaged
foods (up 26% yoy). Moreover, losses reduced both yoy and qoq by `18cr and `22cr
respectively boosted by better product mix and cost curtailment measures. During the
quarter, Sunfeast, Aashirvaad atta and confectioneries grew 32%, 29% and 18%
respectively. ITC made a foray into the fast growing instant noodles market with the
launch of Sunfeast Yippee! in two flavours. Going ahead, we expect revenue traction
in the segment to continue and losses to reduce, albeit at a slower pace than
FY2010 and break-even is likely to be achieved in FY2013.
Hotel business on the road to recovery
ITC’s hotel business registered a robust growth of 20.6% yoy to `225cr (`186cr)
during the quarter. EBIT margins expanded by 80bp yoy to 17.7% driving strong
26.3% yoy growth in EBIT. Construction activity of the new super luxury properties at
Chennai and Kolkata are progressing satisfactorily. We believe that the hotel
business is well on track to post 20% CAGR in revenues during
FY2010-12E aided by a low base and up-tick in economic activity. Moreover,
margins are likely to register significant improvement as ARR’s recover
Paperboard and packaging surprise on margins front
The segment registered a modest growth in revenue of 16.8% yoy (16% at the net
level) to `960cr (`822cr). However, EBIT margins of the segment registered a
significant expansion of 294bp yoy to 25.6% driving a strong 32% yoy jump in EBIT
aided by a combination of product mix enrichment, higher realisations and
enhanced value capture through in-house pulp production. Going forward, we
expect the segment to post a modest 16% CAGR in revenues during FY2010-12
driven by commencement of new units and improvement in margins by ~100bp
aided largely by better product mix.
Agri business registers another quarter of steady revenue growth
ITC’s agri business registered a steady 21.5% yoy growth in revenues to `1,250cr
(`1,028cr), partially aided by a low base and driven by increased sales of soya, leaf
tobacco and wheat. The business maintained its position as the foremost exporter of
leaf tobacco, leveraging the growing demand for Indian tobaccos. EBIT margin
however, contracted by 74bp yoy to 16.2%, resulting in 16% yoy growth in
segmental EBIT. Going ahead, we expect this segment to register 21% CAGR in
revenues over FY2010-12 and margins to remain stable at 11-12% levels owing to
management’s focus to shift to higher profitability products, and firm leaf tobacco
prices.
Investment Rationale
τ Model double-digit sales and EBIT growth in cigarettes: We have modeled in a
1.4% volume growth in cigarette volumes for FY2011 (likely to be back-ended in
2HFY2011E), despite ~15% weighted average price hikes which is likely to fully
offset – 1) ~17% excise hike in Budget and 2) rise in VAT announced in several
states. We believe the cigarette business is well poised to post double-digit sales
and EBIT growth in FY2011E. Moreover, we highlight that over the last 12
months, ITC has strengthened its brand portfolio significantly with brands such
as Flake Excel and Duke Filter, launched Lucky Strike at premium end and
test-marketed 59mm mid-size filter (micro-filters).
τ Non-cigarette EBIT to post 30% CAGR over FY2010-12E: While cigarettes
remain the main profit center, investments in non-cigarette businesses like
FMCG, hotels and paperboards have started yielding positive contribution.
During FY2010-12, we expect non-cigarette EBIT to register 30% CAGR aided by
– 1) reduction in non-cigarette FMCG losses, 2) improvement in hotel margins
aided by higher ARR, and 3) higher margins in paperboards.
τ Return ratios to improve across segments boosting cash flow generation: Over
FY2010-12, we expect return ratios to improve across segments driven by higher
margins (refer Exhibit 19). Moreover, going ahead, we expect capex to plateau
from the peak of FY2007-08 driving strong cash flow generation post dividend
payout at ~50%. Hence, we expect ITC to achieve strong net cash surplus of
`~5,800cr (US $125mn) in FY2012 equating to `15/share.
Outlook and Valuation
We remain positive on ITC’s diversified business model and expect the cigarette
business to witness a better 2HFY2011 in terms of volumes. Moreover, broad-based
growth across segments including potential recovery in hotels, strong growth in
agri-business and reducing losses in the non-cigarette FMCG business will help ITC
sustain strong earnings growth in the ensuing quarters. However, at the CMP of
`171, the stock is trading at 23.3x FY2012E earnings, which is at the upper cap of
its historical valuation band. Hence, we retain our Neutral rating on the stock, with a
Fair Value of `177 based on our SOTP model.
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