Buy ITC: 3QFY11 Results Update: Motilal Oswal

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ITC's 3QFY11 operational results were in line with our expectations. Net sales grew 20.4% to Rs55.1b led by strong
growth in cigarettes (up 18.9%), FMCG (up 23.9%) and the agri-business (up 17.9%). EBITDA margins contracted 50bp
to 18.8% as EBITDA grew 18.8% YoY to Rs20.3b. Other income increased 21% due to gains from sales of investments
(VST Industries and Agro Tech) and a higher yield on debt funds. PAT grew 21.4% to Rs13.9b.
 Cigarette volume growth a pleasant surprise, margin expansion 70bp: Net sales grew 15.6% to Rs27.7b led
by ~12.5% realization growth in 3QFY11. The realization increase was led by a price increase and mix improvement,
enabling EBIT growth of 17% (margin expansion of 70bp to 55.3%). We estimate cigarette volumes to have grown
~2.5% YoY (against our estimate of 2%). We are pleasantly surprised by the traction in volume growth despite ITC's
sharp price increase.
 FMCG, agri divisions post steady growth, paper, hotel recovery slow: New FMCG business sales were up 24%
YoY at Rs11b and EBIT loss declined 15% to Rs736m (loss of Rs669m in 2QFY11). The fall in losses was led by an
improved product mix in biscuits and staples, supply chain efficiencies and increased benefits of scale. The agriculture
business' sales were up 18% and EBIT grew 35.5% YoY, enabling margin expansion of 90bp. The hotels business'
revenue grew 13.7% to Rs2.8b, which in our view was disappointing, given the economic recovery and pick-up in
occupancy rates. Paper and paperboard sales rose 8.1% YoY to Rs8.8b and EBIT fell 5% YoY to Rs1.9b, due to
uncertainty over statutory warnings.

 Budget to be a near-term variable: We are positive about the long term volume growth opportunity in cigarettes.
However FY12 volume growth will be a function of the excise hike in the upcoming Budget. Preempting the changes
in excise duty, ITC increased prices by ~4.2% on its portfolio. Sustained reduction in losses in the FMCG and other
divisions and strong traction in the agriculture business are positive. The hotels business is recovering slowly and
expected to pick up in the coming year. We expect a strong rebound by the paper and paperboard business in the
coming quarter. Our estimates are unchanged after the incorporation of housekeeping changes (increase in share
capital due to ESoPs and higher other income). We estimate 16.5% PAT CAGR over FY11-13. The stock trades at
22.5x FY12E EPS and 19.4x FY13E EPS. Maintain Buy with an SOTP-based target price of Rs190

 

ITC's 3QFY11 operational results were in line with our expectations.
 Net sales grew 20.4% to Rs55.1b (against our estimate of Rs54b) led by strong growth
in cigarettes (up 18.9%), FMCG (up 23.9%) and the agriculture business (17.9%).
 EBITDA margins contracted 50bp to 18.8% as EBITDA grew 18.8% YoY to Rs20.3b
(against our estimate of Rs20.3b).
 Other income increased 21% due to a gain from the sale of investments (VST Industries
and Agro Tech) and a higher yield on debt funds.
 PAT grew 21.4% to Rs13.9b (against our estimate of Rs13.4b).
 Cigarette sales grew 15.6% (volume growth of 3%) and EBIT grew 17% enabling
margin expansion of 70bp to 55.3%.
 New FMCG sales grew 23.8% and EBIT losses declined 14.4%. The agriculture
business grew 17.9% and EBIT growth was 35.5% due to better margins in leaf
tobacco business.

Cigarette volumes up 2.5%, higher prices, better product mix enable 70bp
margin expansion
We estimate cigarette volume growth at ~2.5% YoY (est 2%); we note that price increases
of more than 15% have been well absorbed in the market. Net sales grew 15.6% to
Rs27.7b led by ~12.5% realization growth during the quarter. Realization increase was led
by price increase and mix improvement enabling EBIT growth of 17% (margin expansion
of 70bp to 55.3%). Godfrey Philips’ launch of Marlboro compact and rising presence in
East and South India has not yet impacted ITC’s competitive positioning. Pictorial warnings
change has been pushed ahead by 2 years; however, the date of implementation is not
clear. Even if we assume that the notification date is Dec-2009, the current packaging will
sustain till at least Dec-2011.

ITC has already started effecting price increases ahead of the budget (prices up ~4% in
the current QTD); we do not rule out further hikes in run up to the budget. We would view
an excise increase <10% to be very positive for category expansion. However, excise
increase above teens would be negative for volume growth in the near term; we highlight
increased resilience of cigarette volumes to price increases over the past couple of years.
Our current estimates model in 5% excise increase and 6% volume growth for FY12 and
FY13.
FMCG others: sales up 24%, EBIT losses down 15% YoY, packaged foods,
stationery drive growth
 ITC's New FMCG business sales were up 24% YoY at Rs11b and EBIT losses declined
15% to Rs736m (2QFY11 loss Rs669m). Branded packaged food completed the fourth
consecutive quarter of profitable growth.
 Branded packaged food sales grew 24% led by Sunfeast Biscuits (up 28%) and Bingo
(up 48%). In 3QFY11 ITC launched Sunfeast Yipee! Noodles, which has been well
received by consumers. In staples, ITC scaled up its presence in spices through the
launch of Ashirvaad Rasam and Sambhar.
 ITC has maintained 3% market share in shampoo and increased its share in soaps to
6% (5% in 2QFY11). It aims to increase its market share to 10% in soaps and 7-8%
in shampoo over 3-4 years. Skin cream has been well accepted and it has a new
variant in shampoo.

 Education and stationery products grew 50% YoY. The leadership position of Classmate
is being leveraged to enhance ITC's position in scholastic products with ITC's foray
into products like geometry boxes, pens, pencils and highlighters.
 A sharp reduction in losses was led by an improved product mix in biscuits and staples,
supply chain efficiency and increasing benefits of scale.
 We expect ITC's FMCG and others' EBIT losses to fall 15% in FY11 and 30% in
FY12.

Agri business: sales grow 18%, commodity inflation in soya, coffee boost
margins
ITC's agriculture business posted an 18% increase in sales to Rs10.7b and EBIT grew
35.5% YoY enabling margin expansion of 90bp. The leaf tobacco business posted higher
margins due to stable selling prices even as sourcing costs declined in India. The business
gained due to a surge in trading volumes, particularly in soya and coffee. We believe the
recent run-up in agriculture commodities also boosted margins. ITC is setting up a new
leaf tobacco facility in Karnataka, which will start processing in 12 months.

Hotels business: sales up 20%, EBIT margins up 95bp
ITC's hotels business revenue grew 13.7% to Rs2.8b, a tad disappointing as a double-digit
increase in ARR (average revenue per room) was neutralized by muted growth in
occupancy levels (~67%) due to commissioning of new properties in ITC's key markets.
EBIT grew 16.1% to Rs886m enabling margin expansion of 65bp to 31.5%. Recovery in
the hotels business is expected to accelerate over 2-3 quarters. The commissioning of a
600-room Chennai property (expected by 2QFY12) will increase capacity by 20% and
boost growth.

Paper and paperboards: external sales strong; performance hit by
uncertainty over statutory warnings
Paper and paperboard sales increased 8.1% YoY to Rs8.8b and EBIT declined 5% YoY
to Rs1.9b. The segment's margin contracted 300bp YoY and 500bp QoQ. External sales
were strong in 3QFY11 led by higher volumes and an improved mix (higher share of value
added products). However, sales of packaging material for cigarettes were impacted by
uncertainty regarding graphic statutory warnings. We believe replenishment of cigarette
packaging inventory will enable the company to recoup a significant part of lost sales of
3QFY11. The commissioning of another 0.1mt paperboard line will boost operating
performance in FY13.

Cigarette volumes surprise positively; Budget a near-term variable;
maintain Buy
We are positive about the long-term volume growth opportunity in cigarettes. However
FY12 volume growth would be a function of the excise hike in the upcoming Budget.
Preempting changes in excise, ITC increased prices by ~4.2% on its portfolio. Sustained
reduction in FMCG others' losses and strong traction in the agriculture business are positive.
The hotels business is in a slow recovery phase and should pick up in the coming year. We
expect a strong rebound from the paper and paperboards business in the coming quarter.
Our estimates are unchanged after the incorporation of housekeeping changes (increase
in share capital due to ESoPs and higher other income). We estimate 16.5% PAT CAGR
over FY11-13. The stock trades at 22.5x FY12E EPS and 19.4x FY13E EPS. Maintain
Buy with a SOTP-based target price of Rs190.

Company description
ITC, an associate of BAT (British American Tobacco),
controls more than two-thirds of India's cigarette market.
ITC has emerged as a diversified conglomerate with a
leading presence in paperboard, hotels and processed foods.
E-Choupal, the company's agri-rural initiative, has been
widely appreciated for its foresight in harnessing rural
market potential.
Key investment arguments
 ITC has strong pricing power due to a dominant share
in the cigarette market.
 Its paperboard business has achieved self sustenance
levels.
 Its hotel business recovering steadily.
Key investment risks
 Increase in excise in the forthcoming Budget could be
a risk to volume growth assumptions for cigarettes.
 Higher-than-expected losses in its New FMCG business
will impact profitability.
Recent developments
 ITC entered the high growth instant noodles market
with Sunfeast Yippies brand.
 ITC plans to add 1,500 rooms in 3-4 years (addition of
~50% of existing capacity).
 Strong mix improvement in the paper and paperboard
division due to a higher share of value-added products.
Valuation and view
 Our EPS estimates are Rs7.5 for FY12 and Rs8.7 for
FY13. We estimate 16.5% PAT CAGR over FY11-13.
 The stock trades at 22.5x FY12E EPS and 19.4x FY13E
EPS. Maintain Buy with an SOTP based target price
of Rs190.
Sector view
 We are positive about the long-term demand growth in
the cigarette business due to rising affordability and huge
demand potential in small towns and rural areas.
 Non-cigarette businesses like hotels and paper can fund
their own growth and demand potential is strong.