CLSA - ITC

Cash machine
ITC’s FY13 annual report highlights: a) ROE expanding to an all-time high led by an
improvement in new FMCG and agri; b) while increase in working capital
moderated OpCF growth, lower capex helped and FCF rose 26%; c) cigarette prices
in India today are highest relative to income and illegal cigarettes form ~18% of
the market; d) ESOPs granted at ~0.8% of outstanding capital. We continue to rate
ITC as O-PF and revise up our SoTP based target price to Rs370/sh.

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FY13 return ratios at all-time high, again
ITC’s RoE continued to move up and touched an all-time high of 36% in FY13, up
~7ppt in the past three years and 60bps YoY. RoEs are being driven up largely by
improving margins and slightly higher asset turns. Interestingly, ITC’s cigarette
business RoCEs declined along with hotels and paperboards while new FMCG and agri
saw an improvement. ITC’s working capital also rose five days YoY (+Rs7.8bn) in FY13
due to a reduction in payable days even while receivables/inventory days were flat.
Strong cash generation; FCF: +23% YoY
ITC’s FY13 capex declined 13% YoY off a high base to Rs20.8bn – investments
continued across businesses with 26% invested in cigarettes and 33% in paperboards
(new capacity). While the rise in OpCF was muted at 12% due to higher working
capital, FCF rose by a strong 23% YoY. We believe that the capex has peaked in FY12
and expect average capex over FY14-16 should be similar to FY13. On the back of this,
FCF should rise at 25% Cagr over FY14-16CL which is ahead of EPS Cagr of ~17.5%.
Indian biri is affordable but cigarettes are most expensive
Few worrying facts presented in the report: a) 17% world population in India compares
with just 1.8% cigarette consumption due to prevalence of other formats like ‘biri’; b)
60% of cigarette smokers in India consume other tobacco forms; c) comparisons
indicate that cigarette prices in India are highest relative to its income while biris are
cheaper; d) illegal cigarettes are now at ~18% and India is the fifth largest market.
0.8% ESOPs granted
ITC granted 0.8% of outstanding shares as ESOPs in FY13 cf. 1%+ in the past six
years. The annual report also states that if the company had used black-Scholes model
for valuing these options, the reported earnings would have been lower by 5%. ITC
remains the most prolific issuer of ESOPs in our FMCG coverage universe.
Maintain O-PF
AT 27.5x one year forward earnings, the stock trades at a premium to five year
average, which is justified given its increasingly diversified earnings profile, strong
cash flow and improvement in new FMCG which should break even in FY14. We note
that ITC’s dividend pay-out (ex-special) is up from 50% in the past five years to 65%+
now and there exists potential for a further increase in coming years. We revise our
SoTP based target price for Jun-14 at Rs370/sh.