BofA Merrill Lynch,:: ITC- BUY -Well placed in uncertain monsoons

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TC Limited
   
Well placed in uncertain
monsoons; Resume with Buy
„Resuming coverage with Buy rating, PO of Rs235
We reinstate ITC with Buy and a PO of Rs235. While the stock has outperformed
the market by about 25% YTD and is trading at the higher end of its five-year
historical trading range of 13-30x, we believe, the current valuation does not bake
in (1) improving earnings profile as reflected 5% jump in return ratios, (2)
successful diversification and (3) lower monsoon led risks vs peers.  
Cigarette demand intact with resilient margins
ITC is the leader in the Indian cigarette market with about 70% market share. Its
pricing power in cigarettes imparts resilience to margins, reflected in its consistent
profitability improvement. We estimate cigarette volume to grow 6-7% YoY over
the medium term with 30bp YoY margin gains led by (1) category growth given
under-penetration, and (2) dominant market share as well as pricing power.
Diversification on track; margins to improve over FY11-13
Over time, ITC has successfully diversified by scaling up non-cigarette segments
and assumed leadership positions in the respective categories. We expect these
segments to contribute another 300bp to earnings by FY14, to 22%, led by (1)
capacity increase in hotels/ paperboards and (2) breaking even in fast-moving
consumer goods (FMCG). This will lead to around a 5% jump in return ratios.      
Monsoon led risks lower vs peers
We see lower monsoon-related risks to ITC’s earnings vs peers given its revenue
profile. Our DCF-based PO of Rs235 is in line with SOTP and offers 16% upside
potential. Risks: (1) competitive FMCG intensity could delay breaking even; (2)
severe monsoon failure could impact raw material availability.
TC Limited
   
Well placed in uncertain
monsoons; Resume with Buy
„Resuming coverage with Buy rating, PO of Rs235
We reinstate ITC with Buy and a PO of Rs235. While the stock has outperformed
the market by about 25% YTD and is trading at the higher end of its five-year
historical trading range of 13-30x, we believe, the current valuation does not bake
in (1) improving earnings profile as reflected 5% jump in return ratios, (2)
successful diversification and (3) lower monsoon led risks vs peers.  
Cigarette demand intact with resilient margins
ITC is the leader in the Indian cigarette market with about 70% market share. Its
pricing power in cigarettes imparts resilience to margins, reflected in its consistent
profitability improvement. We estimate cigarette volume to grow 6-7% YoY over
the medium term with 30bp YoY margin gains led by (1) category growth given
under-penetration, and (2) dominant market share as well as pricing power.
Diversification on track; margins to improve over FY11-13
Over time, ITC has successfully diversified by scaling up non-cigarette segments
and assumed leadership positions in the respective categories. We expect these
segments to contribute another 300bp to earnings by FY14, to 22%, led by (1)
capacity increase in hotels/ paperboards and (2) breaking even in fast-moving
consumer goods (FMCG). This will lead to around a 5% jump in return ratios.      
Monsoon led risks lower vs peers
We see lower monsoon-related risks to ITC’s earnings vs peers given its revenue
profile. Our DCF-based PO of Rs235 is in line with SOTP and offers 16% upside
potential. Risks: (1) competitive FMCG intensity could delay breaking even; (2)
severe monsoon failure could impact raw material availability.