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UBS Investment Research
ITC
C igarettes—cash engine on a roll
�� Our top pick; catalysts for the stock
We think key catalysts for ITC’s share price performance include: 1) quarterly
volume growth; 2) cigarette price increases; 3) an improving consumer
environment; and 4) declining losses, market winners in the FMCG business.
�� Cigarette volume and EPS estimates raised
We raise our FY12 cigarette volume estimate for ITC from 5.5% to 6.6% and our
FY12 EPS estimate from Rs7.9 to Rs8.1. In this note, we address concerns over the
sensitivity of cigarette volumes and EPS to tax rates, as well as the expected
graphic warnings on packs from November 2011.
�� Improving trend despite VAT hiccups
Of late, there have been tax increases in some states, raising VAT (state-level sales
tax) rates. We believe a 5% incremental tax would not change our volume
estimates for FY12, but a 10% increase would lower our volume estimate from
6.6% to 5.7%. For our base case scenario, we raise our volume estimate for
cigarettes from 5.5% to 6.6% in FY12.
�� Valuation: raise our price target to Rs240
We raise our price target for ITC from Rs220 to Rs240 while maintaining our Buy
rating. We derive our price target from a DCF-based methodology and explicitly
forecast long-term valuation drivers using UBS’s VCAM tool (assuming a 10.5%
WACC and a 12% interim period growth rate). At our price target, ITC would
trade at 25x 1-year forward PE compared with 24x 1-year forward PE at our earlier
estimates.
Investment Thesis
ITC is our top pick in the consumer staples sector. The stock has
outperformed the BSE Index 37% YTD. We raise our price target for ITC
from Rs220 to Rs240 while reiterating our Buy rating. We base our price
target on our DCF methodology, assuming a 10.5% WACC and a 12%
interim period growth rate.
We think key catalysts for ITC include: 1) quarterly volume growth, driven
by increasing disposable income; 2) price increases; 3) an improving
consumer environment, since hotels start doing better then; and 4) declining
losses in the other FMCG business.
We address the following questions in this note:
1. What would be the impact of tax increases on cigarette volume growth?
While the Indian Budget 2011 did not increase excise duty on cigarettes,
there have been tax increases in some states, raising VAT (state-level sales
tax) rates. This has caused some concern given some of the more important
(high contribution in total volume) states have increased VAT rates. We
increase our FY12 volume estimate for cigarettes from 5.5% to 6.6%.
2. What would be the impact of graphic warnings on packs?
We believe the preference of ‘mass’ consumers towards buying ‘loose
cigarettes’ instead of packs will make the impact of the graphics on the
volumes of cigarettes purchased minimal
3. What is our belief in ITC’s consumer staples business?
Strategically, we believe the other consumer business is very important. ITC
has narrowed its loss from Rs4.8bn in FY09 to Rs2.9bn in FY11.
Management expects the business to turn profitable in two to three years.
Key catalysts
Cigarette volume growth: We have increased our cigarette volume
estimate from 5.5% to 6.6% for FY12. In Q1 FY12, ITC’s cigarette business
surprised positively on volumes, growing at ~8% YoY, while the improved
revenue mix and price increases contributed another ~7-8% to total revenue
growth.
Price increases to pass on taxes: Along with healthy volume growth,
we believe ITC will introduce price increases to pass on the increase in VAT,
without much impact on volumes. It has already announced two price
increases this calendar year—a 10% increase each in Goldflake Regular
Filter in Q4 FY11 and Classic Filters on 1 August 2011.
Improving consumer environment: ITC’s portfolio is skewed towards
top-end consumption given the hotels, apparel and the King-Size cigarette
business. The consumer staples business as well is skewed to the value-add
products launched—an improvement in the consumer environment would
help the business prospects for all these divisions.
Declining losses in other FMCG business: ITC’s consumer business
losses were slightly higher than estimated in Q1 FY12 at Rs763m (UBS
estimate: Rs600m) due to raw material cost inflation. We expect this to be
passed on from Q2 onwards as competing brands have already introduced
price hikes. ITC has guided for a ~20% reduction in consumer business
losses every year.
Improvement in payout: While ITC paid out 43% in FY10 and 69% in
FY11, we believe the run rate for dividend payout, which has been ~40-45%,
will improve to ~55-60%. This is an important catalyst as cash deployment
into other lower-return diversifications is going to be an incrementally
smaller proportion of total cash flow—a positive catalyst for the stock.
Risks
We believe the potential risks to our estimates are: 1) implementation of Goods
and Services Tax (GST) at a higher-than-expected rate of 20%; 2) higher losses
in the consumer business; and 3) regulatory issues hampering growth in the
cigarette business.
Valuation and basis for our price target
We derive our price target from a DCF-based methodology and explicitly
forecast long-term valuation drivers using UBS’s VCAM tool. We assume a
10.5% WACC and an interim growth rate of 12%. We maintain our Buy rating
ITC
ITC is the leading cigarette manufacturer in India with a 67% share of the
market by volume and 83% by value. ITC has identified tobacco and
paperboard, hotels and agribusiness as its core businesses.
Statement of Risk
We believe higher excise duty is the key risk to ITC’s earnings growth and
valuation. A steady increase in excise duty would adversely affect the long-term
growth trend and lead to lower purchases by smokers.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
ITC
C igarettes—cash engine on a roll
�� Our top pick; catalysts for the stock
We think key catalysts for ITC’s share price performance include: 1) quarterly
volume growth; 2) cigarette price increases; 3) an improving consumer
environment; and 4) declining losses, market winners in the FMCG business.
�� Cigarette volume and EPS estimates raised
We raise our FY12 cigarette volume estimate for ITC from 5.5% to 6.6% and our
FY12 EPS estimate from Rs7.9 to Rs8.1. In this note, we address concerns over the
sensitivity of cigarette volumes and EPS to tax rates, as well as the expected
graphic warnings on packs from November 2011.
�� Improving trend despite VAT hiccups
Of late, there have been tax increases in some states, raising VAT (state-level sales
tax) rates. We believe a 5% incremental tax would not change our volume
estimates for FY12, but a 10% increase would lower our volume estimate from
6.6% to 5.7%. For our base case scenario, we raise our volume estimate for
cigarettes from 5.5% to 6.6% in FY12.
�� Valuation: raise our price target to Rs240
We raise our price target for ITC from Rs220 to Rs240 while maintaining our Buy
rating. We derive our price target from a DCF-based methodology and explicitly
forecast long-term valuation drivers using UBS’s VCAM tool (assuming a 10.5%
WACC and a 12% interim period growth rate). At our price target, ITC would
trade at 25x 1-year forward PE compared with 24x 1-year forward PE at our earlier
estimates.
Investment Thesis
ITC is our top pick in the consumer staples sector. The stock has
outperformed the BSE Index 37% YTD. We raise our price target for ITC
from Rs220 to Rs240 while reiterating our Buy rating. We base our price
target on our DCF methodology, assuming a 10.5% WACC and a 12%
interim period growth rate.
We think key catalysts for ITC include: 1) quarterly volume growth, driven
by increasing disposable income; 2) price increases; 3) an improving
consumer environment, since hotels start doing better then; and 4) declining
losses in the other FMCG business.
We address the following questions in this note:
1. What would be the impact of tax increases on cigarette volume growth?
While the Indian Budget 2011 did not increase excise duty on cigarettes,
there have been tax increases in some states, raising VAT (state-level sales
tax) rates. This has caused some concern given some of the more important
(high contribution in total volume) states have increased VAT rates. We
increase our FY12 volume estimate for cigarettes from 5.5% to 6.6%.
2. What would be the impact of graphic warnings on packs?
We believe the preference of ‘mass’ consumers towards buying ‘loose
cigarettes’ instead of packs will make the impact of the graphics on the
volumes of cigarettes purchased minimal
3. What is our belief in ITC’s consumer staples business?
Strategically, we believe the other consumer business is very important. ITC
has narrowed its loss from Rs4.8bn in FY09 to Rs2.9bn in FY11.
Management expects the business to turn profitable in two to three years.
Key catalysts
Cigarette volume growth: We have increased our cigarette volume
estimate from 5.5% to 6.6% for FY12. In Q1 FY12, ITC’s cigarette business
surprised positively on volumes, growing at ~8% YoY, while the improved
revenue mix and price increases contributed another ~7-8% to total revenue
growth.
Price increases to pass on taxes: Along with healthy volume growth,
we believe ITC will introduce price increases to pass on the increase in VAT,
without much impact on volumes. It has already announced two price
increases this calendar year—a 10% increase each in Goldflake Regular
Filter in Q4 FY11 and Classic Filters on 1 August 2011.
Improving consumer environment: ITC’s portfolio is skewed towards
top-end consumption given the hotels, apparel and the King-Size cigarette
business. The consumer staples business as well is skewed to the value-add
products launched—an improvement in the consumer environment would
help the business prospects for all these divisions.
Declining losses in other FMCG business: ITC’s consumer business
losses were slightly higher than estimated in Q1 FY12 at Rs763m (UBS
estimate: Rs600m) due to raw material cost inflation. We expect this to be
passed on from Q2 onwards as competing brands have already introduced
price hikes. ITC has guided for a ~20% reduction in consumer business
losses every year.
Improvement in payout: While ITC paid out 43% in FY10 and 69% in
FY11, we believe the run rate for dividend payout, which has been ~40-45%,
will improve to ~55-60%. This is an important catalyst as cash deployment
into other lower-return diversifications is going to be an incrementally
smaller proportion of total cash flow—a positive catalyst for the stock.
Risks
We believe the potential risks to our estimates are: 1) implementation of Goods
and Services Tax (GST) at a higher-than-expected rate of 20%; 2) higher losses
in the consumer business; and 3) regulatory issues hampering growth in the
cigarette business.
Valuation and basis for our price target
We derive our price target from a DCF-based methodology and explicitly
forecast long-term valuation drivers using UBS’s VCAM tool. We assume a
10.5% WACC and an interim growth rate of 12%. We maintain our Buy rating
ITC
ITC is the leading cigarette manufacturer in India with a 67% share of the
market by volume and 83% by value. ITC has identified tobacco and
paperboard, hotels and agribusiness as its core businesses.
Statement of Risk
We believe higher excise duty is the key risk to ITC’s earnings growth and
valuation. A steady increase in excise duty would adversely affect the long-term
growth trend and lead to lower purchases by smokers.
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