ITC: Pricier puff

ITC hasn't raised the prices of all brands

ITC's cigarette price hike ranges between five and nine per cent. At first look, this seems to be enough to offset the hike in excise duty in the Budget.

Excise on cigarettes had been raised by 10 per cent in the Budget, which effectively had an impact of around 5 per cent on the selling price, since excise accounts for about 50 per cent of the selling price of cigarettes.

But it's important to note that ITC hasn't raised prices of all brands "" it has left the prices of many brands including Capstan and Bristol untouched. This means that the weighted average increase in selling price could be less than five per cent.

Yet, there's hardly any concern that this would impact the company's financials in a major way. The Supreme Court ruling earlier this year against state governments imposing luxury tax would result in improved profitability and cash flows next fiscal.

The only concern is that volume growth could be impacted because of price increases in core brands such as Wills Navy Cut and Gold Flake. Volume growth has been impressive so far this fiscal at around 7 per cent.

Nevertheless, even if volume growth dips, earnings growth is expected be over 20 per cent in FY06, given the expected improvement in margins.

ITC trades at around 14 times estimated FY06 earnings, which seems cheap based on expected earnings growth. But ITC's relatively low discounting has more to do with the plethora of regulatory risks the company is prone to.

ONGC

ONGC is planning to set up a Rs 4,000 crore refinery in Barmer, Rajasthan. This refinery is planned with an initial capacity of 5 million tonnes per annum and would process the crude oil from Cairn Energy's oil block at this site.

ONGC holds 30 per cent interest in Cairn's two oil fields in this block. Setting up this refinery is logical as gross refining margins are expected to remain firm in the medium term, largely due to strong global demand for petroleum products. ONGC is understood to be in discussion with Cairn about the equity holding pattern for this project.

This upstream company has been a key beneficary of higher crude prices "" its gross realisations from sales of crude in the first two months of this quarter have been estimated at $45 per barrel, a y-o-y growth of about 50 per cent.

The company's share of subsidy losses for the first two months of Q4 FY05, as per the formula worked out earlier with oil marketing companies (OMCs), was estimated by analysts at Rs 900-Rs 925 crore. Subsidy burden for the company was Rs 1,332.02 crore in Q3 FY05 and Rs 973 crore in Q2 FY05.

However, a larger turnover due to improved realisations is expected to help the company grow its net profit in FY06 by about 55 per cent, on a y-o-y basis.

Apart from the refinery project planned at Barmer, ONGC is also evaluating the possibility of raising the capacity of its subsidiary Mangalore Refinery and Petrochemicals Ltd to 30 million tonne.

Meanwhile, investor optimism has led this stock to gain about 12 per cent over the last month versus a mere 2 per cent gain in the Sensex.

Structural change and the stock market

A large part of the debate on the inflows being seen by India funds revolves around whether there's a structural change underway in India.

The reason why inflows into Indian equities are far higher than their weight in the MSCI index is because there's a fundamental change in the Indian economy that makes Indian companies far more attractive.

Insurer AMP Sanmar's Senior International Economist & Strategist Alan Jacobs points out that Indian companies have outperformed others, so far as earnings per share are concerned. The chart shows that, in the post-reform period from 1991, earnings per share of Indian companies had grown much faster than global earnings per share.

So there is a strong fundamental basis that attracts flows to India, apart from the liquidity factor. What have been the reasons for the outperformance? Jacobs lists the transition from a relatively high inflation country to a relatively low inflation country as the most important one, which has helped drive the cost of capital lower.

Of course, there are other factors as well, such as Indian companies becoming more efficient as they were faced with competition. Jacobs points out that price-earnings ratios are today much lower than during previous peaks in the Sensex, which makes the current rally far more sustainable on valuation considerations.

According to him, the valuation in the Indian market is neutral at the moment, which means that the returns in the market will now be a function of earnings growth, rather than on account of a higher PE. All this is fine, but isn't earnings growth likely to slow going forward?

Merrill Lynch's global fund manager survey for March found that global earnings per share growth is expected to be 6.9 per cent on average in the next 12 months. That's almost half the forecasts for Indian EPS growth in FY06.

With contributions from Mobis Philipose and Amriteshwar Mathur