Cigarettes puff up sentiment towards ITC

Price hikes in key brands boost cigarette revenues 5%, margins up 107 bps year-on-year to 36.4%

Expansion in the operating profit margin of the cigarettes business was a key positive in ITC’s results for the March quarter (Q4), and so were flat volumes given that analysts were 

expecting a decline in the latter. While price hikes in the Classic, Gold Flake and Navy Cut brands helped cigarette revenues rise five per cent, margins in the business expanded 107 

basis points year-on-year (y-o-y) to 36.4 per cent; sequentially, these were lower by 20 basis points. 

The performance of the hotels and paper businesses were also worth a mention. It was the agri and non-cigarette FMCG (FMCG) businesses that proved a drag. Nonetheless, since 

cigarette accounts for over 85 per cent of profits, the healthy outlook for the business is a positive.

Sales growth in its FMCG segment was just six per cent and profits were down y-o-y. But, the recovery (sales up 12.3 per cent) from the lows seen in Q3 after demonetisation provide 

relief. Going ahead, with the segment's margins contracting y-o-y in Q4 due to higher input costs, continued pressure in the wholesale channel and investments towards brand 

building, and goods and services tax (GST) implementation ahead, its performance will be watched by the Street. 

Overall, revenues grew 14 per cent to Rs11,126 crore and lagged the Bloomberg consensus estimate of Rs11,854 crore. Softness in both FMCG and agri margins pulled down 

overall Ebitda margin by 185 basis points y-o-y to 34.8 per cent. A fall in tax rate helped but still the 12.1 per cent increase in net profit to Rs2,669 crore was lower than Bloomberg 

estimates of Rs2,725 crore. 

The cigarettes business’s good show was cheered by the Street as the ITC scrip gained three per cent after hitting a new 52-week-high of Rs313.4. The stock has risen 11 per cent 

since May 18 as the GST rate on cigarettes (a key overhang on the stock) will be largely revenue-neutral. While investors are still awaiting finer details such as whether the GST rate will 

be applied on gross or net invoice value, expectations are that it is unlikely to be much higher than the prevailing taxes. 

However, the regulatory overhang on cigarettes is far from over. “According to media statements made by Finance Minister Arun Jaitley, the ‘cess’ and specific excise duty will be 

increased over the next five years to add to the compensatory fund that the government will use to compensate the states for the deficit in their tax collections. Thus, though cigarette 

volumes could improve in FY18, they will be determined by the budgetary announcements thereafter,” says Sagarika Mukherjee, analyst at Elara Capital.

The Street, though, seems little worried on this aspect. Most analysts are positive on ITC and expect the cigarette segment's margins to grow at a healthy clip going forward. Any further 

improvement in FMCG business will support ITC's overall performance and sentiment. At the current levels, the ITC scrip trades at 31x FY18 estimated earnings which are higher than 

its five-year average valuation of 27x but 30 per cent lower than the FMCG sector’s valuations.