Cigarettes maker ITC has again delivered a robust set of numbers for the quarter ended December 31, 2012. The key highlights of the results were the strong performance of cigarettes business as well as reducing losses of FMCG business. The stock currently trades at 24.3 times FY14 estimated earnings and analysts believe these valuations should be sustainable over the medium term. Most analysts remain positive on the company given the consistent performance of its cigarettes business (high teen profit growth over the past six years), high return ratios, strong brand equity and pricing power.
Analysts expect ITC to deliver 22% earnings growth over FY12-15 driven by strong margin expansion in the cigarettes business and breakeven of the fast growing FMCG business. "ITC’s solid competitive positioning and consistency of cigarette earnings delivery should support premium valuations. We reiterate buy, with a modest target price increase to Rs 340. ITC remains our preferred consumer pick," says Jamshed Dadabhoy of Citigroup. Experts are ruling out any significant increase in excise duty in this year’s Budget (given the steep hike last year) and believe any correction in the stock price prior to the Budget will provide a good entry point.
Small cigarettes: The next 'big' thing
For the quarter ended December 2012, ITC beat Street estimates driven by strong growth in its cigarettes business. Notably, cigarettes volumes have grown at 1-2% for the quarter, pushing EBIT (earnings before interest and tax) margins of this segment to 21.1%.
Resilience of ITC's cigarettes business can be assessed by the fact that despite a hike of 16% in its average realisation for the nine months of this fiscal, volumes have have grown. Analysts also remain positive on the margin expansion story in this division. "ITC’s Q3'FY13 results further reinforce our conviction that EBIT growth trajectory of its cigarette business has increased to 20% plus, compared to consensus estimates of 15% as seen over FY02-12", says Anand Mour, FMCG analyst at ICICI Securities. Going forward, analysts expect ITC's cigarettes volumes to be driven by increased traction in the small cigarette (64 mm length) segment as consumers up trade from other tobacco products to cigarettes (given the low entry point as well as that 14 states have banned gutka and chewing tobacco products). This could push up the March 2013 quarter cigarettes volume growth to 6% and for FY13 to 2%, say analysts.
While the company has successfully passed on (through price hikes) higher excise duty as well as VAT burden, implementation of ad-valorem duty structure (introduced in last Budget and later withdrawn) remains key risks as it can impact the company's profitability.
FMCG breakeven in FY14
ITC's FMCG segment has been posting a strong 20% plus revenue growth for the past six-seven quarters. In the December quarter as well, this segment's revenues grew by 30.1% (on 15-18% volume growth). All its categories namely, biscuits, soaps, wheat flour have grown well in the quarter. The company hopes to witness pick up in the shampoos segment on the back of recent re-launches. The EBIT losses from this segment have also narrowed to Rs 24 crore as against Rs 68 crore in March 2011 quarter. A break-even in this segment would boost sentiments significantly, which analysts expect by early FY14.
Amongst other segments, agri business surprised positively on revenues (up 43%) as well as EBIT (up 21%) growth - driven by wheat exports. On the other hand, hotels and paper business disappointed with muted EBIT performance. Higher input costs restricted paper business' EBIT growth to mere 2%, while hotels' EBIT fell by a whopping 46%. ITC's hotels business is likely to be under pressure in the near-term and continue to report lower return ratios due to the slowdown in tourist as well as business traveller segments and the company's continued investments in new properties. However, the opening up of its Chennai property should provide some cushion to this segment.