ITC: Gains led by price hikes priced-in

ITC raised prices of select cigarette brands by over 10.3 per cent on Monday

ITC raised prices of select cigarette brands (Gold Flake Kings, Gold Flake Lights and Classic) by over 10.3 per cent on Monday. This follows a seven per cent increase announced in July 2013, both of which were taken to offset increase in duties.

While the price rises will support the company's margins (possibly provide a leg-up) and help sustain profit growth in the cigarette business, volumes could come under pressure. Historical trend suggests that price increases have helped ITC sustain margins and profit growth in the cigarette business, but price hikes beyond eight per cent has negatively impacted near-term volume growth. Notably, in the June quarter as well, ITC's cigarette volumes fell two per cent and given the quantum of price hikes, a similar situation cannot be ruled out for the September 2013 quarter. This follows muted quarterly cigarette volume growth of 0.5-2.5 per cent in FY13.

V Srinivasan, FMCG analyst, Angel Broking, says, “This price hike was on expected lines. We believe cigarette volumes will fall one-two per cent in the current quarter as well. Historically, volumes pick up from the second-third quarter (of price hike) onwards. Thus, volumes could recover in the December quarter.” Srinivasan has a Neutral rating on the stock.

According to a senior analyst at Sharekhan the latest price rise will result into stronger margins for the company. “Volumes will continue to remain under pressure in the next two quarters but the latest hike would ensure better margins for the Kolkata-based company,” he said.

From the stock perspective though, the gains are not significant as most analysts believe their current estimates capture any margin gains from recent price hikes.

  Nitin Mathur, consumer research analyst , Espirito Santo Securities, says, “Recent price hikes are carried out to reduce the impact of excise duty hikes on the margins. However, the margin expansion is built up in current estimates. While we believe volumes could remain under pressure in the next few quarters, the 64 mm cigarettes will be key driver of volume growth.” He estimates ITC's Ebitda margin to expand 40 basis points to 35.7 per cent in FY14.

The price of ‘Gold Flake Kings’ pack consisting of 10 cigarettes will now cost Rs 75, as against earlier price of Rs 68. A pack of ‘Gold Flake Lights’ consisting of 20 cigarettes will cost Rs 75 compared to Rs 68 earlier.  Likewise, the 'Classic' pack consisting of 20 cigarettes will now cost Rs 150 from Rs 136 earlier.

Analysts explain the cigarette business is price elastic so market will take some time to absorb the recent back to back price hike but consumption won’t be affected.

Meanwhile, ITC’s other FMCG business, which had reported a profit in the March quarter, again fell in the red in the June quarter. A sustained turnaround in this business is crucial to perk up sentiments further.

On the whole, analysts remain confident about ITC posting healthy growth of over 15 per cent in earnings in FY14. At Rs 302, the stock trades at 27 times FY14 estimated earnings and appears to be attractively priced, given its historical one-year forward average PE of 32 times. Most analysts are positive on the stock given the strong cash flow generation, high pricing power and diversified business. Out of the 14 analysts polled by Bloomberg last month, only one has Neutral rating on ITC stock, while rest have Buy recommendation. The average target price stands at Rs 372, or 23 per cent upsides from current levels.