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Cigarette Taxes key to re-rating: Buy
ITC reported yet another steady quarter with ~7.5% cigarette volume growth and sustained expansion in margins across FMCG and Paperboards business. Cigarette demand outlook remains positive, sans any sharp increase in GST rates in coming months. FMCG business faces near term demand headwinds, however long term trajectory of double digit topline growth, category expansion and steady increase in margins looks intact (108bps EBIT margin expansion in FY19, target of double digit margins in 5 years) post restructuring of lifestyle retailing business. Paperboard business is in fine fettle given gains from steady prices and benign input costs. Hotels ARR and occupancy indicates steady improvement in profits, however we are far off from pre 2009 profitability. ITC trades at 22.7xFY21 EPS, 35-40% discount to our coverage universe and 2% dividend yield limits downside in the stock. We believe that stable cigarette taxation regime can re-rate the stock. Retain “Buy” with SOTP based target price of Rs369 (Rs364 earlier).
* Cigarettes volumes up ~7.5%; EBIT up 10%:
Stable taxation and pricing is aiding the revival in cigarette volumes on a low base. 64mm continues to grow ahead of the pack and is now more than 40% of volumes. ITC increased prices in a few RSFT brands like Capstan, Flake Excel and Bristol between 6.7-14.6% in 4Q the impact of which will be reflected in coming quarters. Stability/ small increase in GST rates remains key for sustained recovery in cigarette volumes; our estimates factor in 5.3% cigarette volume growth for FY19-21.
* FY19 FMCG EBIDTA margin at 5.5%:
4Q FMCG Sales grew 7.3%, excluding lifestyle restructuring it grew by 10%. EBITDA grew by 30% to Rs2.28bn. EBIT at Rs1.31bn increased 43% with market share gains in most categories. Dairy, Juices and Biscuits saw sustained innovations in Foods while Charmis, floor cleaner and Deo’s were key drivers in HPC. FY19 EBIT margins have expanded 108bps to 2.5%, expect steady gains given lower drag from Lifestyle retailing in FY20, lower losses in personal care and benefit of scale up in various processed foods products.
* Hotels ARR and Occupancy up, margins drag:
EBIT increased 17.5% on 24.9% increase on 110bps margin decline as improvement in ARR (4-5%), higher occupancy levels (more than 60%) and F&B sales were offset by costs associated with initial ramp up in new properties at Goa and Hyderabad
* Paperboard and Paper
sales grew 18.2% as EBIT increased 24% on 90bps margin expansion led by lower input costs, higher in-house pulp and recovery in cigarette volumes. The rebuild of 1.5lakh ton machine for VA paperboards has increased the profitability and will continue to do so in coming periods.
* Agri Business
sales increased 16.2% however, EBIT increased by 18.8% on 10bps margin expansion. Improved leaf tobacco crop and poor global demand impacted volumes while opportunity in wheat, oilseeds and supply to processed foods aided growth.
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