Flash: buy ITC - Price increased in cigarettes; yet again :: Edelweiss

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n  Price increases in cigarettes

According to our channel check, Gold Flake prices are increased by INR 3 to INR 38 (~8.6% price increase), for a pack of 10 sticks. Earlier, ITC increased prices of Bristol cigarettes to INR 28 from INR 25 (~12% price increase). Our channel check also suggests price hikes for Gold Flake Light, Gold Flake King Size and Gold Flake Premium in coming weeks.

n  Volume to recover H2FY11 onwards; new products to add value

Volumes decline in cigarette business was less than 1% Y-o-Y in Q2FY11 vis-à-vis ~3.5% Y-o-Y in Q1FY11. We expect volume growth to recover from H2FY11 onwards. Gold Flake Premium Lights (regular size filter cigarette priced at INR 35 for 10 sticks) brand will be rolled out in Western India soon. Cigars are the fastest growing segment of the tobacco market; ITC’s Armenteros, a hand-rolled cigar, will soon be available in major metros.

n  Budget impact hard to decipher; other businesses doing well

Though it is hard to understand whether ITC’s above price hikes are in anticipation of the budget excise duty increase, we note that even in worst years, the company has managed to raise cigarette EBIT by ~10-12%. We expect its: (1) FMCG business to turn profitable by FY13 (foods is already profitable); (2) Agri to do well, driven by high leaf tobacco prices in export markets; (3) Hotels to post strong growth following higher average room rate (ARR) and occupancy rate; (4) higher margins in the Paper segment with improved efficiency in new pulp mill and rising paper costs.

n  Outlook and valuations: Positive; re-iterate ‘BUY’

We highlighted in our sector report, “Indian FMCG sector: Hopes and concerns…”, dated November 16, 2010, that pricing power will continue to improve for FMCG in CY11. Despite hike in excise duties in several Union budgets and subsequent rise in cigarette prices by ITC, the company’s margins have improved and profits have grown, indicating its pricing power and inelastic nature of cigarette demand. ITC is relatively insulated from commodity inflation in FY12, owing to benign tobacco prices and competition risk is low as Marlboro is limited to 3 cities. We re-iterate ‘BUY’ on ITC and it is one of our top pick in the FMCG pack. On relative return basis, stock is rated ‘Sector Outperformer’.