ITC has test launched 64mm cigarettes (Capstan at INR2.0/stick, Gold Flake at INR2.5/stick) in UP and Bihar; an expected move due to the ~40% tax differential between 64mm and 69mm categories. Though we perceive this as positive, we expect limited volumes (1-2% of total cigarette volumes) due to high price differential (INR2/stick against INR1/stick) with smuggled contraband cigarettes (~INR18bn market; ~10% of industry). Competitors like VST are also testing this category in Chhattisgarh and Andhra Pradesh. ITC has recently hiked prices of its Sunfeast biscuits (Dark Fantasy by 10%, Bourbon by ~18%) and soaps (Vivel 90gm soap by 5%). Although FY13 cigarette volumes are expected to be flattish, we are positive on cigarette business’ earnings growth due to margin expansion and turnaround of FMCG business. Maintain ‘BUY’.
Superior distribution to help grab share from contraband offerings
ITC’s 64mm range is priced at a significant discount to its 69mm cigarettes (available at INR3.5 and INR4.0), though at a premium to illegal cigarettes (INR1/stick). As consumer loyalty in cigarette consumption is high, we expect limited cannibalisation impact. We expect market share gain from illegal cigarettes due to ITC’s superior distribution network; some step up from bidis to 64mm will also drive this category’s growth.
Premiumisation focus to boost FMCG break even by H2FY13
With its premium offerings in FMCG space doing well, we believe the recent price hikes to have little impact on volumes. Launch of soap, shampoo, talcum powder & face wash in Vivel and Fiama Di Wills and variants in Sunfeast reflect ITC’s premiumisation focus. In Q4FY12, losses of FMCG business dipped 75% with ~23% rise in sales and 413bps margin expansion YoY (some seasonal benefit of stationary business).
Outlook and valuations: Positive; maintain ‘BUY’
At CMP, the stock is trading at 27.1x and 23.4x FY13E and FY14E, respectively. We reiterate ‘BUY’ and ‘Sector Outperformer’ rating on a relative return basis.