ITC: Weak margins in cigarettes biz disappoint

Lower base restricts decline in cigarette volumes, which have seen a sharp drop in past few quarters

A weak show by its cigarettes business was the key pressure point in ITC’s December  quarter results. For the first time in multiple quarters,  earnings before interest and taxes (Ebit) margin contracted by 156 basis points year-on-year (y-o-y) to 68.1 per cent. The absence of price hikes and a higher share of low-value cigarettes are seen as key reasons.

Cigarette volumes, too, declined by an estimated three-nine per cent, positive as it has fallen in double-digits in each of the past four preceding quarters.

The reasons are not clear, though. The lower fall in cigarette volumes could be partly because of a low base effect in the December 2014 quarter, when volumes fell 13-14 per cent. Abneesh Roy of Edelweiss considers it a conscious call taken by the management not to implement price hikes in the quarter. This move will enable ITC to protect its market share from illegal cigarette manufacturers, he adds. If true, it has come at the cost of profitability, a concern as cigarettes have been the key earnings driver and a cash cow, too, providing growth funds to ITC’s other businesses.

  For now, most analysts believe the margin decline in cigarettes is a quarterly phenomenon and should improve. While the jury is out on this, the cigarette business’ revenues grew 5.7 per cent y-o-y to Rs 4,380 crore in the quarter, while segment Ebit was up 3.4 per cent at Rs 2,984 crore.

The consumer goods segment, the second largest revenue contributor, too, was impacted. Weakness in rural demand and the Chennai floods saw revenues grow 7.1 per cent to Rs 2,478 crore. Despite higher expenses on branding and innovation, operating profit of Rs 19 crore was up 63.6 per cent y-o-y aided by lower costs. Importantly, its instant noodles brand regained momentum led by strong communication to reinstate faith in its quality and safety, and could emerge as a growth lever.

Among others, the hotels and agri businesses were a drag on profits, while the paper division saw a 14 per cent rise in profits on benign input costs.

In this backdrop, revenues grew 2.6 per cent y-o-y to Rs 9,177 crore, way below the Bloomberg consensus estimate of Rs 9,451 crore. A higher tax rate (up 309 basis points to 33.8 per cent) also weighed on its net profit, which grew a measly 0.7 per cent y-o-y to Rs 2,653 crore missing estimates of Rs 2,756 crore. While results were disappointing, sentiments are likely to remain weak on worries of duty hikes in the upcoming Budget.