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Top pick among large caps in consumer
Cigarette business should
deliver despite uncertainty on
changes in taxation
Action: Reaffirm BUY on strong earnings growth expectations
We maintain our BUY rating on ITC, with an upgraded TP of INR229 as
we roll forward our valuations by one year and make minor adjustments to
our earnings estimates for FY12F and FY13F. Our earnings are largely
unchanged, although our revenue assumptions have increased with
expectations for margin performance becoming more muted.
Catalysts: Cigarette volume growth to surprise on the upside
The 1Q results demonstrate significant traction in the cigarette business,
with volume growth of 8%. We believe this trend may continue for the rest
of the year, which would mean strong revenue and earnings growth in
FY12F.
FMCG business performance on track
The non-cigarette FMCG business performance remains on track, with
ITC now the second-largest player in the instant noodles category within
six months of launch. HPC brands continue to drive revenue growth, with
losses likely to decline as per the company’s earlier guidance.
Valuation: Valuation discount vs HUVR unwarranted; BUY
ITC trades at a 14% discount to HUVR on FY13F earnings, which we
believe is unwarranted. On our estimates, ITC will deliver average 16-17%
earnings growth over the next two years, while HUVR will deliver close to
12% over the same period. We see ITC as a much better place to be
within the large-cap consumer space in India.
Strong start to Q1 gives confidence on full-year delivery
ITC’s 1Q FY12 results were ahead of our expectations at the revenue line, helped by
stronger-than-expected growth in the core cigarette division. EBITDA margin decreased
by 70bps y-y against our expectation of flat margin performance. Other income was
higher and PAT came in 7% higher than our expectations.
Key highlights of the 1Q FY12 results
• ITC’s 1Q FY12 results were ahead of our estimates at the top line, with the core
cigarette business driving the outperformance. Volume growth of the cigarette business
was 8% ahead of our estimate of 6%. This is a positive surprise for the rest of the year.
• Net revenue of INR57.67bn (up 19.7% y-y) was 4% ahead of our estimates, led by
strong growth in the cigarette and paper divisions.
• EBITDA rose 17.2% to INR18.8bn. EBITDA margins declined by 70bps y-y to 32.7%.
EBITDA performance was hit by losses in the other FMCG business and the seasonally
weak performance of the hotels business.
• PAT came in at INR13.32bn vs.INR10.7bn last year, up 24.5% y-y. This was ~7%
higher than our estimate, although helped by other income of INR 2.36bn
Strong revenue growth performance during the quarter
• The core cigarette business saw revenues rise +15.7% y-y to INR 28.74bn.
Volume growth was 8% for the quarter, ahead of our estimate of 6%. We
expect this to be a key positive driver for the remaining quarters of FY12.
• Among the other divisions, revenue of the agri business rose +26.5% to
INR17bn, ahead of our expectations.
• The paper business also exceeded our expectations, with revenue up +20.9%
to INR9.59bn.
• The hotels business was hit by seasonality with revenue +9.8% to INR2.3bn.
• The FMCG business reported strong revenue growth during the quarter, with
revenue +19.6% to INR11.97bn.
Profit performance was a mixed bag
• Profit performance of the core cigarette division was +20.8% y-y to INR15.7bn. Margins
improved by 233bps y-y.
• Agri division EBIT rose +27.7% y-y to INR1,571mn, although margins were largely flat
y-y.
• EBIT growth of the hotels business was 33.2% with margins showing a marked
improvement of almost 400bps. As revenue growth picks up over the next three
quarters, we expect the hotels business to perform strongly through the rest of the year.
• Losses in the other business have come down y-y to INR763mn.
Changes to estimates
We have made some changes to our assumptions, mainly for the cigarette business,
which leads to changes to our earnings estimates for FY12F and FY13F. Our earlier
assumption was for volume growth momentum to pick up to 4% in FY12F, but with 1Q
FY12 indicating that momentum has been significantly ahead, we now expect volume
growth to be closer to 8% for the year.
We also expect the company to continue to raise prices selectively through the year,
which should help the cigarette business deliver strong revenue growth for the year. With
the other businesses also on a strong footing, the company should deliver ~16%
revenue growth for the year, on our estimates.
Our revenue upgrade of close to 7-9% over FY12F and FY13F is on account of audited
FY11 numbers being 6% ahead of our estimates. Therefore, the real upgrade is only to
the tune of 2-3% or so, driven mainly by more constructive assumptions on volume and
value growth for the cigarette business.
We also expect the improved momentum of the cigarette business to have a positive
impact on margins. We expect margins to move higher by close to 30bps y-y in FY12F
and by 60bps in FY13F, as operating leverage and lower raw material prices have a
positive impact on profitability.
Changes to our target price
We are moving our target price higher from INR200 to INR229, up 14.5%. Of this
change, a large part is on account of the roll forward of our earnings by one year, with
the earnings upgrade contributing a small part.
Within our SoTP valuation, we have made certain changes
– We have moved up the target multiple for the cigarette business from 22x earlier to
23x now to reflect the strong expected growth over the next few years. Valuations
across the consumer sector have also moved up, which implies that for a cashgenerative business like ITC, we believe the valuation multiple should be closer to the
consumer average. We point out that consumer valuations are close to 24x FY13F,
and our valuation of the cigarette business still gives a discount of 4% to the sector
average.
– We are also valuing the consumer business at 3x FY13F sales now vs. 2.5x sales
earlier on account of an improvement in performance. ITC is now the second-largest
company in the instant noodles market. In soaps, the company has taken its share to
more than 5% now. HPC brands such as Vivel have a strong consumer franchise
and, we believe, the company can build on it in the next few years. Recently, the
chairman also stated that in the longer term, ITC aims to grow its FMCG business to
be the largest in the country. We believe with sustained investment behind brands,
the company can, over the next few years, achieve a much larger scale, which should
be reflected in valuations.
– There are no other changes to our valuation methodology.
Risks. Policy directives from the union government form the biggest risk to our target
price.
Spectre of excise duty hike can hold back short-term performance
The government did not make any changes to the excise duty structure in the budget
earlier this year. However, according to recent newsflow (CNBC August 4, 2011), the
government could look to hike the excise duty during the year or possibly during the
budget early next year. However, as per a Bloomberg report, Mr S Dutt Mujumdar,
chairman of the Central Board of Excise and Customs stated that the government is not
looking to make any changes in the excise duty structure during the year. However,
uncertainty around government actions can keep stock price performance muted in the
short-term, in our view.
We note that this reaction is not new. Stock price performance, historically, has been
relatively muted going into a budget, but has outperformed six months after the budget.
Recent stock price history underpins this thesis.
Valuations still lower than the sector average
Valuations are still lower than the sector average of our coverage universe by more than
5%. With ITC looking set to deliver another robust year of earnings, we believe
valuations should be at a premium to the sector average.
We believe ITC is much better protected against raw material increases and has pricing
power which is better than most other companies in the sector. We are building in only a
modest 30bp improvement in FY12F. Continued strong performance in the cigarette
division could lead to margin outperformance vs. our expectations.
ITC is currently trading at a 14% discount to Hindustan Unilever (HUVR IN, REDUCE),
which is unwarranted in our view. We expect ITC will deliver earnings growth of close to
17% on our numbers vs. HUL at close to 12% over the next 2 years. ITC is also trading
at a discount to other mid-cap consumer names, such as Dabur and Marico, where
pricing power is much more limited. We see this valuation gap on the back of a higher
growth trajectory as being unjustified and would be switching out of HUVR and into ITC
at these levels.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Top pick among large caps in consumer
Cigarette business should
deliver despite uncertainty on
changes in taxation
Action: Reaffirm BUY on strong earnings growth expectations
We maintain our BUY rating on ITC, with an upgraded TP of INR229 as
we roll forward our valuations by one year and make minor adjustments to
our earnings estimates for FY12F and FY13F. Our earnings are largely
unchanged, although our revenue assumptions have increased with
expectations for margin performance becoming more muted.
Catalysts: Cigarette volume growth to surprise on the upside
The 1Q results demonstrate significant traction in the cigarette business,
with volume growth of 8%. We believe this trend may continue for the rest
of the year, which would mean strong revenue and earnings growth in
FY12F.
FMCG business performance on track
The non-cigarette FMCG business performance remains on track, with
ITC now the second-largest player in the instant noodles category within
six months of launch. HPC brands continue to drive revenue growth, with
losses likely to decline as per the company’s earlier guidance.
Valuation: Valuation discount vs HUVR unwarranted; BUY
ITC trades at a 14% discount to HUVR on FY13F earnings, which we
believe is unwarranted. On our estimates, ITC will deliver average 16-17%
earnings growth over the next two years, while HUVR will deliver close to
12% over the same period. We see ITC as a much better place to be
within the large-cap consumer space in India.
Strong start to Q1 gives confidence on full-year delivery
ITC’s 1Q FY12 results were ahead of our expectations at the revenue line, helped by
stronger-than-expected growth in the core cigarette division. EBITDA margin decreased
by 70bps y-y against our expectation of flat margin performance. Other income was
higher and PAT came in 7% higher than our expectations.
Key highlights of the 1Q FY12 results
• ITC’s 1Q FY12 results were ahead of our estimates at the top line, with the core
cigarette business driving the outperformance. Volume growth of the cigarette business
was 8% ahead of our estimate of 6%. This is a positive surprise for the rest of the year.
• Net revenue of INR57.67bn (up 19.7% y-y) was 4% ahead of our estimates, led by
strong growth in the cigarette and paper divisions.
• EBITDA rose 17.2% to INR18.8bn. EBITDA margins declined by 70bps y-y to 32.7%.
EBITDA performance was hit by losses in the other FMCG business and the seasonally
weak performance of the hotels business.
• PAT came in at INR13.32bn vs.INR10.7bn last year, up 24.5% y-y. This was ~7%
higher than our estimate, although helped by other income of INR 2.36bn
Strong revenue growth performance during the quarter
• The core cigarette business saw revenues rise +15.7% y-y to INR 28.74bn.
Volume growth was 8% for the quarter, ahead of our estimate of 6%. We
expect this to be a key positive driver for the remaining quarters of FY12.
• Among the other divisions, revenue of the agri business rose +26.5% to
INR17bn, ahead of our expectations.
• The paper business also exceeded our expectations, with revenue up +20.9%
to INR9.59bn.
• The hotels business was hit by seasonality with revenue +9.8% to INR2.3bn.
• The FMCG business reported strong revenue growth during the quarter, with
revenue +19.6% to INR11.97bn.
Profit performance was a mixed bag
• Profit performance of the core cigarette division was +20.8% y-y to INR15.7bn. Margins
improved by 233bps y-y.
• Agri division EBIT rose +27.7% y-y to INR1,571mn, although margins were largely flat
y-y.
• EBIT growth of the hotels business was 33.2% with margins showing a marked
improvement of almost 400bps. As revenue growth picks up over the next three
quarters, we expect the hotels business to perform strongly through the rest of the year.
• Losses in the other business have come down y-y to INR763mn.
Changes to estimates
We have made some changes to our assumptions, mainly for the cigarette business,
which leads to changes to our earnings estimates for FY12F and FY13F. Our earlier
assumption was for volume growth momentum to pick up to 4% in FY12F, but with 1Q
FY12 indicating that momentum has been significantly ahead, we now expect volume
growth to be closer to 8% for the year.
We also expect the company to continue to raise prices selectively through the year,
which should help the cigarette business deliver strong revenue growth for the year. With
the other businesses also on a strong footing, the company should deliver ~16%
revenue growth for the year, on our estimates.
Our revenue upgrade of close to 7-9% over FY12F and FY13F is on account of audited
FY11 numbers being 6% ahead of our estimates. Therefore, the real upgrade is only to
the tune of 2-3% or so, driven mainly by more constructive assumptions on volume and
value growth for the cigarette business.
We also expect the improved momentum of the cigarette business to have a positive
impact on margins. We expect margins to move higher by close to 30bps y-y in FY12F
and by 60bps in FY13F, as operating leverage and lower raw material prices have a
positive impact on profitability.
Changes to our target price
We are moving our target price higher from INR200 to INR229, up 14.5%. Of this
change, a large part is on account of the roll forward of our earnings by one year, with
the earnings upgrade contributing a small part.
Within our SoTP valuation, we have made certain changes
– We have moved up the target multiple for the cigarette business from 22x earlier to
23x now to reflect the strong expected growth over the next few years. Valuations
across the consumer sector have also moved up, which implies that for a cashgenerative business like ITC, we believe the valuation multiple should be closer to the
consumer average. We point out that consumer valuations are close to 24x FY13F,
and our valuation of the cigarette business still gives a discount of 4% to the sector
average.
– We are also valuing the consumer business at 3x FY13F sales now vs. 2.5x sales
earlier on account of an improvement in performance. ITC is now the second-largest
company in the instant noodles market. In soaps, the company has taken its share to
more than 5% now. HPC brands such as Vivel have a strong consumer franchise
and, we believe, the company can build on it in the next few years. Recently, the
chairman also stated that in the longer term, ITC aims to grow its FMCG business to
be the largest in the country. We believe with sustained investment behind brands,
the company can, over the next few years, achieve a much larger scale, which should
be reflected in valuations.
– There are no other changes to our valuation methodology.
Risks. Policy directives from the union government form the biggest risk to our target
price.
Spectre of excise duty hike can hold back short-term performance
The government did not make any changes to the excise duty structure in the budget
earlier this year. However, according to recent newsflow (CNBC August 4, 2011), the
government could look to hike the excise duty during the year or possibly during the
budget early next year. However, as per a Bloomberg report, Mr S Dutt Mujumdar,
chairman of the Central Board of Excise and Customs stated that the government is not
looking to make any changes in the excise duty structure during the year. However,
uncertainty around government actions can keep stock price performance muted in the
short-term, in our view.
We note that this reaction is not new. Stock price performance, historically, has been
relatively muted going into a budget, but has outperformed six months after the budget.
Recent stock price history underpins this thesis.
Valuations still lower than the sector average
Valuations are still lower than the sector average of our coverage universe by more than
5%. With ITC looking set to deliver another robust year of earnings, we believe
valuations should be at a premium to the sector average.
We believe ITC is much better protected against raw material increases and has pricing
power which is better than most other companies in the sector. We are building in only a
modest 30bp improvement in FY12F. Continued strong performance in the cigarette
division could lead to margin outperformance vs. our expectations.
ITC is currently trading at a 14% discount to Hindustan Unilever (HUVR IN, REDUCE),
which is unwarranted in our view. We expect ITC will deliver earnings growth of close to
17% on our numbers vs. HUL at close to 12% over the next 2 years. ITC is also trading
at a discount to other mid-cap consumer names, such as Dabur and Marico, where
pricing power is much more limited. We see this valuation gap on the back of a higher
growth trajectory as being unjustified and would be switching out of HUVR and into ITC
at these levels.
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