Web view: ITC rides high on the predictability factor

Post budget, the firm's PE relative to Sensex is up from 1.6 times to 2 times, indicating investors are willing to pay for robust cash flows and low risk of govt intervention

With India's macro-economic condition uncertain, investors are increasingly turning towards defensive spaces such as FMCG to avoid getting caught in the downward spiral. So it was no surprise when consumer goods major ITC touched its all time high last week when the markets were extremely range bound. What is that that makes this company a safe haven?

Since the announcement of the union budget, ITC's PE (price-to-earnings) relative to BSE Sensex has expanded from 1.6 times to 2 times, which underscores that premium investors are willing to pay for predictability of earnings, robust cash flows and low risk of government intervention.

Deutsche Bank in its company note zeroed in on the 'predictability factor’ as one of the major reasons to raise its target price by 22% to Rs 270/share.

With the union budget now behind us, the much-speculated risk of rise in excise duty has reduced considerably. This leaves ITC in a sweet spot as any rise in excise duty would have hampered ITC's valuations driven strongly by its cigarette business as the company has a strong pricing power owing to its monopoly in this space.

Even as compared to its peers, ITC will be able to manage its margin profile much better as central excise and state VAT (two of the biggest cost building factor) is largely fixed for FY13. So, at 25x one yr forward earnings, the stock currently trades at a 13% discount to the one year forward PE multiple of the consumer sector (ex-ITC) of 29 times.

Another factor which bodes well for the stock price is the continually declining loss in its FMCG business. A 23% revenue compounded annual growth rate between financial year 2010 and 2012 in the FMCG segment is a reflection of the scale benefits that this business has been able to generate. It currently enjoys presence in hair care, personal wash, skin care and biscuit segment. Also, there are plans to extend its FMCG portfolio with launches in chocolates, milk products etc. which will help extend its reach in the food business.

However, one huge impending negative for the stock is the implementation of Goods and Service Tax (GST) in its current form which leaves alcohol and tobacco products out of its ambit. This will disable the state governments to increase State GST leaving them with no other option but to hike taxes on alcohol and tobacco products. But this is some time away.

So until then, ITC may continue to enjoy the premium of the 'predictability factor’.