ITC Limited- Steady through the storm :: JPMorgan

ITC remains our preferred consumer pick. Tobacco is amongst few Indian
consumer businesses whose pricing power is intact given low competition,
high entry barriers, its habit forming nature and strong brand affinity. We
think tobacco is the most defensive of consumer staples sectors and ITC has
outperformed markets during difficult times. Aggressive price hikes this fiscal
will overshadow volume weakness and support mid-teens earnings growth in
our view. Steadily expanding margins for cigarettes, stable capex needs
coupled with improved profitability of other FMCG businesses would lead to
higher FCF generation and eventually higher dividend payout in our view. The
combination of reasonable valuations and relative security of earnings
estimates makes it our preferred pick in the staples space.
 A play on pricing power. While cigarette volume offtake is likely to remain
subdued in FY14 (we estimate -3% decline), ITC’s medium-term investment
case will depend on pricing power which drives earnings much more than
volumes. Price hike of ~18-20% for its cigarette portfolio likely over the
year would be substantially higher than c12-13% increase needed to offset
the excise/VAT hike and would drive at least mid-teens EBIT growth in our
view over FY14. Over last five years ITC’s cigarette revenue and EBIT have
grown at a CAGR of 16% and 18% despite cigarette vol CAGR of 2%.
Better offtake for 64mm cigarettes (where excise was kept unchanged) could
help offset some volume weakness in FY14.
 Non-tobacco business – Stable outlook. We expect better profitability for
other FMCG business supported by healthy sales growth, increased scale
and improved mix in FY14. Paper business expansion remains on track with
volume growth likely to pick up for this segment and product mix
improvement continuing to drive realisation/margin growth. Agri business is
expected to deliver steady mid-teens EBIT growth. Hotel business will
likely be an outlier with macro challenges impacting growth outlook here.
 FCF and dividend payout to maintain upward trend. Healthy cigarette
EBIT growth, steady growth for paper/agri businesses, improving
profitability for other FMCG business, stable capex requirements (18-20bn
p.a.) should lead to higher FCF and may lead to increased dividend payout
over time.

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