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ITC Limited
Inflation proof
Investment rationale
Resilience of the cigarette business would aid outperformance
Over the next 12 months, when FMCG companies would be muddled between
input cost inflation and intensifying competitive scenario, ITC would be in a
better position with its dominating presence and strong pricing power in the
cigarettes division (accounting for 84% of its total profits). ITC has consistently
demonstrated its strong pricing power in the past in a scenario of steep hikes
in cigarette duties and restrictions on cigarette consumption.
Focus on profitability, a positive strategy
In addition to its cigarettes business, ITC is witnessing improved profitability
across majority of its other businesses like agri, paper and non-cigarette
FMCG. It has witnessed margin expansion of 330bps and 1,040bps in paper
and agri business to 21.2% and 18.3% respectively from FY05 to FY10. In
the non-cigarette FMCG business, losses have been pared from INR1,952m
(sales INR5,634m) in FY05 to INR3,495m (sales INR36,417m) in FY10.
Revival in hotels and increase in market share in personal care to act as triggers
Hotels division is expected to witness continued revival during FY11e and
bounce back by FY12e. During the past two quarters, the hotel industry as a
whole has been witnessing revival in occupancy rates due to higher tourist
arrivals and domestic travel. This is expected to be followed by improvement
in ARRs by the end of FY11e.
Valuation and outlook
At the CMP of INR167, the stock trades at a PE of 25.5x FY11e and at 21x
FY12e. We reiterate our BUY recommendation with a target price of INR192,
providing a 15% upside from the current levels. Our target price is based on
our SOTP valuation in which we have valued the cigarette business at 16x
FY12e EV/EBITDA and other FMCG division at 2x FY12e sales and the Agri
business, Paper business and Hotel business at 6x, 6x and 10x FY12e EV/
EBITDA. We believe that the high EV/EBITDA multiple provided to the cigarette
division is in line with the current valuations of its FMCG peers.
Investment rationale
Resilience of the cigarette business would aid outperformance
Over the next 12 months, when FMCG companies would be muddled between
input cost inflation and the intensifying competitive scenario, ITC would be in a
better position with its dominating presence and strong pricing power in the cigarettes
division (accounting for 84% of its total profits). ITC has consistently demonstrated
its strong pricing power in the past in a scenario of steep hikes in cigarette duties
and restrictions on cigarette consumption. While the overall duty in cigarettes has
risen by 14% CAGR during the past five years (FY05-10), ITC's cigarette EBIT grew
by 17% CAGR. ITC's cigarette sales during the same period have grown by 12%
CAGR indicating an improvement in EBIT margins from 22.9% in FY05 to 28.6% in
FY10. During the same period, we estimate that the company has witnessed an
improvement in volume market share from 73% to 78.5%.
Focus on profitability, a positive strategy
In addition to its cigarettes business, ITC is witnessing improved profitability across
majority of its other businesses like Agri business, paper and non-cigarette FMCG. It
has witnessed margin expansion of 330bps and 1,040bps in paper and agri business
to 21.2% and 18.3% respectively from FY05 to FY10. In the non-cigarette FMCG
business, losses have reduced from about INR1,952m (sales INR5,634m) in FY05 to
INR3,495m (sales INR36,417m) in FY10. While the improvement in the paper business
has been aided by improvement in technology and backward integration, improvement
in profits in agri business and reduction in losses in non-cigarette FMCG has been due
to increased focus on higher margin products. The margin improvement in agri business
especially during FY10 has been due to the higher sales of leaf tobacco while the
decline in losses of non-cigarette FMCG business was due to the improvement in product
mix in biscuits. Additionally, decline in commodity prices also led to decline in losses of
the non-cigarette business. Going ahead, we estimate Paper business to post a PBIT
margin expansion of 230bps to 23.5% in FY11and expect other FMCG division to
post lower loss at ~INR2.92bn in FY11e against a loss of INR3.49bn in FY10.
Revival in hotels and increase in market share in personal care to act
as triggers
Hotels division is expected to witness a continued revival in FY11e and to bounce
back by FY12e. During the past two quarters, the hotel industry as a whole has been
witnessing revival in occupancy rates due to higher tourist arrivals and domestic travel.
This is expected to be followed by improvement in ARRs by the end of FY11. We
expect the division to witness ~27.5% PBIT margins during FY11e, while to touch
FY09 profitability of 31% by FY12e. We anticipate the division to record ~28%
CAGR in revenues and ~46% CAGR in PBIT during FY10-12e. This in turn would lead
to a rerating of the division.
Further, the personal care portfolio comprising soaps, shampoos and the recent launch
skin creams is fast gaining traction, especially in case of soaps where ITC has gained
a volume market share of ~5% and has become a force to reckon within. In the current
scenario, where the competition in soaps is intensifying, any further gain in market
share would be commended and would lead to re-rating of the division. Therefore, we
believe that the revival in hotels and the increase in market share in the personal care
would act as triggers for the stock. We expect the other FMCG division to grow by
34% CAGR during FY10-12e to INR65.7bn while losses are expected to reduce to
INR2,302m by FY12e.
Sales to grow 19% CAGR, PAT growth at 22% CAGR
We expect ITC to record accelerated growth of 19% CAGR in sales to INR254bn
during the next two years (FY10-12) led by higher growth in non-cigarette FMCG and
agri business. Profit after tax is expected to grow at a higher rate of 22% CAGR to
INR60.8bn aided by improvement in profitability across all businesses. Cigarette division
is expected to witness improvement in profitability to the tune of 242bps to 31%
during FY10-12e backed by price hikes and richer mix. ITC's FMCG division is expected
to grow by 34% CAGR during FY10-12 to INR65.7bn while losses are expected to
reduce to INR2,302m by FY12e. Hotel is expected to witness 27.5% PBIT margins
during FY11e, while to touch FY09 profitability of 31% by FY12e. We anticipate the
division to record 28% CAGR in revenues and 46% CAGR in PBIT during FY10-12.
This in turn would lead to a rerating of the division. We expect a steady EBIT margin
of about 11.5-12% for ITC's agri division while EBIT margin of the paper division is
expected to witness 234bps to 23.5% during FY10-12e.
Valuation and outlook
At the CMP of INR167, the stock trades at a PE of 25.5x FY11e and at 21x FY12e. The
stock has witnessed a consistent re-rating during FY06-FY11 backed by strong resilience
demonstrated by the cigarette business and increasing contribution to PBIT from noncigarette
businesses. We believe in an inflationary scenario, ITC's premium would expand
and the stock would witness a further re-rating.
We reiterate our BUY recommendation on the stock with a target price of INR192,
providing a 15% upside from the current levels.
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