ITC: Existing pictorial warnings to retain:: ShareKhan

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Event update
The government in its cabinet meeting on Tuesday (December 7, 2010) decided to
retain the existing pictorial warnings on cigarette and bidi packages for a year and
review the same in December 2011. The decision came a week after large tobacco
players (including ITC and Godfrey Phillips) stopped the production of cigarettes
due to the uncertainty surrounding the implementation of pictorial warnings.



Existing pictorial warnings to remain: In May 2010, the health and family
welfare ministry had come out with a notification to replace the existing pictorial
(scorpion on bidi packs and cancer-affected lungs on cigarette packs) warnings
with stern warnings (of cancer-affected mouth) on packs from December 1,
2010. However, considering the demand of the tobacco industry, the government
has decided to retain the existing pictorial warnings on cigarette and bidi packs
for a year.

Decision in favour of cigarette manufacturers: We believe the decision is in
favour of the cigarette manufacturers, as the existing cigarette stock lying
with the retailers cannot be withdrawn and re-manufactured and hence an
unfavourable ruling would have led to a substantial loss for the cigarette
companies. Also, the implementation of the new pictorial warnings would have
increased the printing and packaging cost of these companies.

Production to start soon: Seeking more clarity on the type of pictorial warnings
to be carried on the packs, all the major cigarette manufacturers (such as ITC
and Godfrey Phillips) have stopped the production of cigarettes at their various
facilities (since December 01, 2010). These cigarette manufacturers have stock
of 25-30 days and hence if the production is stalled for more than 30 days it
will affect the supply of these products and consequently the sales of the
respective company. However, with the government decision in favour of the
cigarette manufacturers, we expect the major players to resume production in
the next few days.

Outlook and valuation
The cigarette business contributes around 50% to ITC’s
top line and bottom line both and the cash generated
from the business is utilised to strengthen the future of
the company’s other businesses (which are at a nascent
stage). With the government deciding in favour of the
cigarette manufacturers, the concerns regarding the cashcow
business of ITC are over. Also, the company’s other
businesses such as that of hotels, agri-products and noncigarette
fast moving consumer goods are expected to
maintain their strong growth momentum in the coming
quarters. Hence, we believe this a good time to enter
the ITC stock. At the current market price the stock trades
at 26x its FY2011E earnings per share (EPS) of Rs6.4 and
21.9x its FY2012E EPS of Rs7.6. We maintain our Buy
recommendation on the stock with a price target of Rs191.