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ITC Limited Overweight
ITC.BO, ITC IN
Steady growth story remains on track
Our recent meeting with ITC's management reinforced our confidence in the
company’s ability to deliver EPS CAGR of 18% over FY10-13E. ITC is our
preferred pick in the consumer staples sector and in the current volatile
markets, we think it should do relatively better than its peers.
• Cigarette business trends are encouraging as volume growth revived over
the past few months and is likely to turn positive in 2HFY11. Importantly,
product mix changes remain encouraging and this should be positive for
margins. Lower procurement costs for tobacco (c-10% y/y) should further
support FY12 margins.
• Tobacco and Taxes. Over the next few days there will probably be a debate
on the extent of excise duty hikes likely on cigarettes, particularly in the
backdrop of strained fiscal situation. As demand trends are healthy, we
believe industry can absorb excise duty hike of up to 10% (implying price
hike of 4-6%) without impacting demand meaningfully. At constant prices
the current sensitivity to earnings of excise duty is 1%.
these businesses to achieve EBITDA growth of 27% over FY10-13E which
is nearly twice the growth expected for cigarette business and 900bps higher
than growth of 18% seen in these business in FY08-10. FMCG losses
continue to decline as profitability for food portfolio improves driven by
price hikes and favorable mix. Personal care should benefit from
introduction of new variants and distribution expansion (for skin cream).
• We believe high FCF generation could result in higher dividend payout
in the medium term as capex needs are likely to remain limited to Rs15-
18bn per annum. We estimate FCF CAGR of 15% over FY10-13E.
• Q3FY11 earnings preview. We expect ITC to report Net sales, EBITDA
and PAT growth of 16%, 17% and 16% respectively during Q3FY11. For
the cigarette business, we expect volume growth to be c1% and margins to
expand 40bp y/y.
Volume growth for cigarette business likely to turn positive
in 2HFY11; Margin expansion to sustain
Cigarette business trends are encouraging as volume growth is improving on
sequential basis and is likely to turn positive by Q3FY11. Importantly, product mix
changes continue to remain encouraging with healthy demand for premium brands
which bode well for margins. We estimate company to register 1% volume growth in
Q3FY11 and end FY11 with 0-1% vol growth. Recent price hike for Bristol brand
(by 12% implying wtd avg hike of 1% for ITC’s cigarette portfolio) in our opinion is
also supported by good volume offtake being witnessed by the company.
ITC continues to improve its product portfolio, trying to capture various price points
and has introduced new brands and variants like Lucky Strike, Classic Menthol Rush,
Gold Flake SLK and the recently launched Player’s Gold Leaf brand (positioned at
the premium regular-size filter segment which is now being rolled out nationally).
ITC is currently selling micro filters priced at Rs1.5/stick in few states. While a clear
strategy on this front will likely emerge in coming quarters, we believe this segment
is unlikely to contribute more than 2-3% of cigarette volumes this year as lower
profitability would restrain ITC from aggressively expanding this sub-segment.
Over the next few days there could be a significant debate on the extent of the excise
duty hike likely for cigarettes. As demand trends are healthy, we believe industry can
absorb excise duty hike of up to 10% (implying price hike of 4-6%) without
impacting demand meaningfully. At constant prices the current sensitivity to
earnings of excise duty is 1% on our estimates.
While it is still early days for Marlboro’s Regular Filter cigarette foray (introduced
by Godfrey Philip in October last year), we don't expect any significant impact of
this move in the near term on ITC's cigarette offtake. However this would ensure that
ITC will likely maintain the pace of trade spends and improve its brand visibility to
compete effectively. However pace of distribution expansion and trade spends
commitments by GPI will be an important factor to watch out for.
ITC's tobacco procurement cost for FY12 cigarette consumption is down c10% y/y
implying further support to cigarette EBIT margins in FY12. We expect 180bps
EBIT margin expansion for cigarettes over FY10-13E.
Other FMCG - Profitability is key
We expect overall revenues for other FMCG to grow at 20-25% and expect EBIT
losses to decline by 15-25% p.a. over the next two years. Foods division is doing
well with share gains in biscuits and snacks segment. Also profitability continues to
improve aided by rising scale, in-house manufacturing, price hikes (particularly in
biscuits) and better product mix. It is currently in the process of rolling out its noodle
brand Sunfeast Yippee! across more states
While foods portfolio has achieved operational breakeven, personal care business
will likely see losses over next 4-5 years as brand investments in existing (soaps and
shampoos) and new categories (skin care) will persist.
Recent foray into skin care category under Vivel Active Fair brand has seen good
response so far and this product is in the process of being rolled out nationally.
Enhancing distribution reach, widening product portfolio with new variants, and
improving shelf visibility for its personal care products would be key action points
for ITC in order to garner market share in personal care space in our view.
Hotels – Looking forward to a strong 2HFY11 and FY12
While occupancy levels continue to improve, Average Room Rates have not seen
any meaningful uptick yet. Subdued response to Commonwealth games was however
a demand dampener in the previous quarter. ITC is likely to commission a 600-room
hotel in Chennai in FY12 and by FY13 a boutique resort in Gurgaon (100 rooms) and
a 300-room hotel in Kolkata is likely to be commissioned.
We remain optimistic about growth picking up significantly in 2HFY11 and FY12 as
ARRs will likely firm up. As per our channel checks, room rates in some leading
hotels have been raised by 5-10% over last month or so. We forecast revenue and
EBITDA CAGR of 20% and 32% respectively over FY10-13E for this division.
Steady growth for agri and paper business likely
Traded commodities now account for 40-45% of ITC’s agri business turnover and
profitability and revenue potential for these is quite opportunistic depending on
demand supply trends for these commodities. However we expect current
profitability for agri business to sustain (10-11% EBIT margins) as most agri
commodity prices remain firm and export prices for leaf tobacco are stable (though
leaf procurement costs have come down). We expect agri business revenues and
EBIT to grow at a CAGR of 15% over FY10-13E.
We think better realizations, rich product mix and enhanced value capture through
in-house pulp production will continue to aid healthy margin profile for paper
business. ITC enjoys 65-70% share in value added paperboard (primarily used for
packaging by FMCG and consumer durable companies) which is witnessing 15%+
industry growth. ITC is also planning further capacity expansion for this business
with potential commissioning of 100,000 tonne paperboard (increasing capacity by
25%) by FY12 which should provide boost to volume growth for the division. We
estimate revenue and EBITDA CAGR of 17% and 20% respectively for this
business.
Q3FY11 earnings preview
We expect ITC to report Net sales, EBITDA and PAT growth of 16%, 17% and 16%
respectively during Q3FY11. For cigarette business, we expect volume growth to be
nearly 1% and margins to expand 40bp y/y.
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