ITC: Premium over historical valuations justified :: Credit Suisse

● ITC’s share price correction has brought its P/E in-line with its
3-year average. However, valuations are above its 15-year
average P/E of ~20x, which we believe is deserved given the
significant improvement in FCF, return ratios and business mix.
● ITC’s 15-year average P/E is depressed due to the sharp fall in
valuation during 2001–05. That period saw a de-rating of tobacco
companies globally due to a series of lawsuits which led to very
large penalties on companies in the US. ITC’s diversification into
FMCG and pending excise related cases were also drags.
● ITC’s FCF conversion has sharply improved over FY07–13, going
up from sub-20% to ~80%. ROE has moved up from 26% to 36%.
The share of non-consumer businesses, which rose to a peak of
24% in FY07, is now down to 16% in FY13. Qualitative factors like
competitive risks from Marlboro have also dissipated.
● ITC is largely unaffected by the rupee depreciation, having very
minimal dollar linked costs and some exports. We expect the
company to continue to deliver 18–20% earnings growth. ITC
continues to be our top pick in the FMCG sector.

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2001–04 de-rating was a combination of global and company
specific factors. ITC’s 15-year average 1-year forward P/E is ~20x;
this number is depressed due to the period 2001–05, when the stock
traded at an average P/E of ~12x. There was a confluence of factors
that led to ITC’s stock de-rating from its average P/E of 23x over
1995–00. Globally tobacco stocks de-rated in that period due to
judgements on a series of lawsuits in the US, which led to huge
penalties being put on tobacco companies. In October 2002, a USD28
bn penalty was issued to Phillip Morris by a jury in the US. ITC itself
had excise related cases in India, which were settled in 2005. IT