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ITC (ITC)
Consumer products
Headwinds that are less likely, but still counts. While reiterating our long-standing
positive view on ITC, we look at ‘what can go wrong?’—(1) increase in VAT to 40%
from 20% in Rajasthan probably indicates that there is no upper limit for State VAT, (2)
aggressive marketing by Philip Morris (possible, not probable), (3) Supreme Court’s
activism related to the tobacco sector, (4) Australia could potentially set a precedent in
stricter norms for cigarette packaging and (5) FMCG losses could potentially be higher
in FY2012E. ADD.
Low probability events which can impact ITC. We look at ‘What can go wrong?’
Escaped the Central Budget, however, not the State VAT
Uncertainty exists on taxation structure under GST
Aggressive marketing by Philip Morris (possible, not probable)
Supreme Court’s activism related to tobacco sector portends worry
Australia could potentially set a precedent in stricter norms for cigarette packaging
FMCG losses could potentially be higher in FY2012E
Term of Mr. Y.C. Deveshwar, Chairman, ends in 2012
Escaped the Central Budget not the State VAT. ITC needs to watch for potential increases
in state VAT in FY2012E and beyond. Four recent examples, (1) Gujarat increased the VAT on
cigarettes to 25% (from 20%), (2) Himachal Pradesh increased it to 16% (from 13.75%). It is
interesting to note that VAT on bidis was (also) increased to 16% from 5%, (3) Rajasthan
increased VAT on cigarettes to 40% from 20% and (4) Bihar increasing it to 13.5% from
12.5%. Kerala, Tamil Nadu and West Bengal, key states for ITC (~31% of cigarette sales, in our
view), have not presented the Budget as yet.
Uncertainty on GST. The Working Paper on GST released last year was silent on the rates that
would be applicable on cigarettes. With GST likely to be introduced w.e.f. FY2013E, uncertainty
on rates for demerit goods may likely have an overhang on the stock.
Aggressive marketing by Philip Morris. While we are not worried on the entry of Philip
Morris (Marlboro) in the RSFT segment, we would look out for any aggressive marketing
by it in this space given that ~70% of ITC’s revenues are from this segment. We find that
PM is test marketing innovative concepts like cigarettes in sachets—Marlboro Compact is
available in a 2s pack at a price point of Rs7.
Supreme Court’s activism related to tobacco sector portends worry. While the
Supreme Court’s directive in December 2010 for manufacturers to withdraw plastic
packaging for tobacco products (predominantly sachets) is potentially beneficial for other
forms of tobacco, we believe that at an industry level the increasing involvement of
Supreme Court in the tobacco industry does not portend well.
Australia could potentially set a precedent in stricter norms for cigarette
packaging. Media reports suggest that Australia is likely to introduce plain packaging for
cigarettes in 2012 (continuation of the implementation of WHO rules on tobacco
regulation). While this is likely to be contested by tobacco companies, we believe that if
even a diluted version of this gets implemented, it will set a precedent globally and put
pressure on the other governments (including India) to endorse it given the negative
social connotations attached with cigarette smoking.
FMCG losses could potentially be higher in FY2012E. We have modeled ‘Other
FMCG’ loss of Rs1,221 mn (improvement of 60% over FY2011E) and profit of Rs1,339
mn for FY2012E and FY2013E, respectively. However, losses could potentially be higher
given that the company may need to incur expenses to relaunch its shampoo portfolio
and the Fiama Di Wills brand. Moreover, launch expenses for Yippee noodles may be
higher than budgeted due to the increased activity in this segment by new entrants (GSK,
HUL) as well as the market leader (Nestle).
Term of Mr. Y.C. Deveshwar ends in FY2012E. Some investors believe that
continuation of the current leadership is key to the present business model of ITC. The
term of the present Chairman, Mr. Y.C. Deveshwar ends in 2012. He has commented in
media that “2012 not sacrosanct for end of term at ITC”.
ITC (still) remains our preferred pick (apart from GSK Consumer and Titan)
Our long-standing positive view on ITC remains as it is entering a phase of high FCF
generation and excise duty in Central budget was left unchanged. We model 5% volume
growth in cigarettes (which has upside risks now) and forecast an EPS of Rs8.0 for FY2012E
(+22% growth). Key triggers for the stock are:
Potential for increase in dividend payout ratio. We assign a high probability for an
increase in the dividend payout in FY2010-13E as ITC is likely to generate FCF of Rs156
bn and the company is likely to have cash position of Rs86 bn (Rs11/share) by end-
FY2013E.
We note that in the earlier period of 2003-05, one of the major reasons for rerating of
the ITC stock (from ~12P/E to ~17P/E) was the step-up in dividend payout to ~50% from
~30%.
Improving ROCE as all businesses will likely contribute incrementally to profits and capex
as a percentage of sales is declining.
Reiterate ADD, TP Rs200
Our long-standing positive view on the stock remains as cigarette volumes could surprise
positively in FY2012E due to tailwinds of benign Central budget and continuing strong
demand conditions. While the overhang of VAT increase in Sate budgets does exist, we
highlight that only four States have increased VAT, whereas seven have left it untouched
and three (major) States including Kerala, Tamil Nadu and West Bengal (accounting for
~31% of ITC’s cigarette sales, in our view) are yet to present the budget.
We model 5% volume growth in cigarettes (which has upside risks now) and forecast an EPS
of Rs8.0 for FY2012E (Rs7.8 previously). Retain ADD, target price revised to Rs200 (Rs185
previously). Key risks are (1) unexpected higher losses in other FMCG, and (2) any aggressive
marketing strategy (including trade discounting) by Philip Morris to promote Marlboro.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
ITC (ITC)
Consumer products
Headwinds that are less likely, but still counts. While reiterating our long-standing
positive view on ITC, we look at ‘what can go wrong?’—(1) increase in VAT to 40%
from 20% in Rajasthan probably indicates that there is no upper limit for State VAT, (2)
aggressive marketing by Philip Morris (possible, not probable), (3) Supreme Court’s
activism related to the tobacco sector, (4) Australia could potentially set a precedent in
stricter norms for cigarette packaging and (5) FMCG losses could potentially be higher
in FY2012E. ADD.
Low probability events which can impact ITC. We look at ‘What can go wrong?’
Escaped the Central Budget, however, not the State VAT
Uncertainty exists on taxation structure under GST
Aggressive marketing by Philip Morris (possible, not probable)
Supreme Court’s activism related to tobacco sector portends worry
Australia could potentially set a precedent in stricter norms for cigarette packaging
FMCG losses could potentially be higher in FY2012E
Term of Mr. Y.C. Deveshwar, Chairman, ends in 2012
Escaped the Central Budget not the State VAT. ITC needs to watch for potential increases
in state VAT in FY2012E and beyond. Four recent examples, (1) Gujarat increased the VAT on
cigarettes to 25% (from 20%), (2) Himachal Pradesh increased it to 16% (from 13.75%). It is
interesting to note that VAT on bidis was (also) increased to 16% from 5%, (3) Rajasthan
increased VAT on cigarettes to 40% from 20% and (4) Bihar increasing it to 13.5% from
12.5%. Kerala, Tamil Nadu and West Bengal, key states for ITC (~31% of cigarette sales, in our
view), have not presented the Budget as yet.
Uncertainty on GST. The Working Paper on GST released last year was silent on the rates that
would be applicable on cigarettes. With GST likely to be introduced w.e.f. FY2013E, uncertainty
on rates for demerit goods may likely have an overhang on the stock.
Aggressive marketing by Philip Morris. While we are not worried on the entry of Philip
Morris (Marlboro) in the RSFT segment, we would look out for any aggressive marketing
by it in this space given that ~70% of ITC’s revenues are from this segment. We find that
PM is test marketing innovative concepts like cigarettes in sachets—Marlboro Compact is
available in a 2s pack at a price point of Rs7.
Supreme Court’s activism related to tobacco sector portends worry. While the
Supreme Court’s directive in December 2010 for manufacturers to withdraw plastic
packaging for tobacco products (predominantly sachets) is potentially beneficial for other
forms of tobacco, we believe that at an industry level the increasing involvement of
Supreme Court in the tobacco industry does not portend well.
Australia could potentially set a precedent in stricter norms for cigarette
packaging. Media reports suggest that Australia is likely to introduce plain packaging for
cigarettes in 2012 (continuation of the implementation of WHO rules on tobacco
regulation). While this is likely to be contested by tobacco companies, we believe that if
even a diluted version of this gets implemented, it will set a precedent globally and put
pressure on the other governments (including India) to endorse it given the negative
social connotations attached with cigarette smoking.
FMCG losses could potentially be higher in FY2012E. We have modeled ‘Other
FMCG’ loss of Rs1,221 mn (improvement of 60% over FY2011E) and profit of Rs1,339
mn for FY2012E and FY2013E, respectively. However, losses could potentially be higher
given that the company may need to incur expenses to relaunch its shampoo portfolio
and the Fiama Di Wills brand. Moreover, launch expenses for Yippee noodles may be
higher than budgeted due to the increased activity in this segment by new entrants (GSK,
HUL) as well as the market leader (Nestle).
Term of Mr. Y.C. Deveshwar ends in FY2012E. Some investors believe that
continuation of the current leadership is key to the present business model of ITC. The
term of the present Chairman, Mr. Y.C. Deveshwar ends in 2012. He has commented in
media that “2012 not sacrosanct for end of term at ITC”.
ITC (still) remains our preferred pick (apart from GSK Consumer and Titan)
Our long-standing positive view on ITC remains as it is entering a phase of high FCF
generation and excise duty in Central budget was left unchanged. We model 5% volume
growth in cigarettes (which has upside risks now) and forecast an EPS of Rs8.0 for FY2012E
(+22% growth). Key triggers for the stock are:
Potential for increase in dividend payout ratio. We assign a high probability for an
increase in the dividend payout in FY2010-13E as ITC is likely to generate FCF of Rs156
bn and the company is likely to have cash position of Rs86 bn (Rs11/share) by end-
FY2013E.
We note that in the earlier period of 2003-05, one of the major reasons for rerating of
the ITC stock (from ~12P/E to ~17P/E) was the step-up in dividend payout to ~50% from
~30%.
Improving ROCE as all businesses will likely contribute incrementally to profits and capex
as a percentage of sales is declining.
Reiterate ADD, TP Rs200
Our long-standing positive view on the stock remains as cigarette volumes could surprise
positively in FY2012E due to tailwinds of benign Central budget and continuing strong
demand conditions. While the overhang of VAT increase in Sate budgets does exist, we
highlight that only four States have increased VAT, whereas seven have left it untouched
and three (major) States including Kerala, Tamil Nadu and West Bengal (accounting for
~31% of ITC’s cigarette sales, in our view) are yet to present the budget.
We model 5% volume growth in cigarettes (which has upside risks now) and forecast an EPS
of Rs8.0 for FY2012E (Rs7.8 previously). Retain ADD, target price revised to Rs200 (Rs185
previously). Key risks are (1) unexpected higher losses in other FMCG, and (2) any aggressive
marketing strategy (including trade discounting) by Philip Morris to promote Marlboro.
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