ITC’s Q2FY17 revenue and PAT growth (adjusted for IND–AS) at 9.6% and 10.5% y-o-y, respectively, came in line with our estimates. Second consecutive quarter of positive cigarette volume spurt at 3% y-o-y, albeit on a favourable base (16% y-o-y dip), was positive.
44 bps y-o-y cigarette margin surge was on account of calibrated price hikes. FMCG sales growth, at 13.3% y-o-y, was strong post four quarters of single-digit growth led by new product launches and favourable base in noodles. GST remains key monitorable for cigarette. Maintain Hold.
Cigarette and FMCG maintain good traction
Gross sales of cigarette business jumped 7.1% y-o-y (6.4% y-o-y in Q1FY17) led by 3% y-o-y volume spurt. ITC’s strategy of calibrated price hikes (in more inelastic segment like Kings and lower in price elastic segment like 69 mm) boosted margin 44bps y-o-y with decent volumes. Salience of 64 mm is more than 30% to volumes. FMCG business posted robust growth led by strong spurt in noodles (soft base), Aashirvaad, Bingo!, Engage and new segments like antiseptic (Savlon), juice (B Natural) and dairy. Loss in FMCG business dipped to R33m in Q2FY17 from R111m in Q2FY16.
Rest of the businesses: Muted show
Hotels, agri and paper growth was soft at 2.5%, 2.0% and flattish y-o-y, respectively. Hotel business remains impacted by sluggish environment and excessive room inventory—focus on running hotel business via management contracts will aid return ratios over the long term. While paper business margin benefited from lower raw material prices (170 bps y-o-y margin expansion), agri growth was impacted by lower exports and supplies to the company’s FMCG businesses which is expected to pick up gradually.
Outlook and valuations: Improving; maintain Hold
With per capita consumption 1/18th China’s, cigarette opportunity in India remains attractive. ITC trades at 33% discount to the Edelweiss consumer pack and any relief on GST can lead to potential re-rating of the stock. However, volume sustenance and GST remain key monitorables. We maintain Hold/sp with target price of R278.
Cigarette net sales (revised IND AS compliant) increased 7.1% y-o-y and Ebit growth came in at 8.4% y-o-y. Volumes for the quarter sustained its positive growth, up 3% y-o-y (broadly in line with our expectation, against 3% volume growth in Q1FY17 and a drop of 16% in Q2FY16). Ebit margins expanded by 44 bps and 121 bps y-o-y and q-o-q and came in 37.7%. Cigarette industry continues to face legal headwinds but inspite of the same, the company has posted 3% volume growth, albeit on negative 16% drop in Q1FY16. Over the last 4 years, the incidence of excise duty and VAT on cigarettes, at a per unit level, has gone up cumulatively by 118% and 142% respectively thereby exerting severe pressure on legal industry volumes even as illegal trade grows unabated. Besides adversely impacting the performance of the legal cigarette industry, this has led to sub-optimisation of the revenue potential from the tobacco sector.
The operating environment for the legal Cigarette industry in India has been rendered even more challenging during the quarter in the wake of a further increase of 10% in excise duty announced in the Union Budget 2016 as well as introduction of the new 85% graphic health warnings (GHW) on cigarette packages. The Company is currently manufacturing cigarettes with 85% warning in compliance with the interim requirements pending final decision by the Karnataka HC on the matter. Despite the challenging operating environment, the company continues to consolidate its market leadership through relentless focus on delivering quality products, continuous innovation & value addition and best-in-class execution.
ITC’s FMCG revenue grew by 13.3% y-o-y, on the back of good growth across most of the segments. Such growth has helped the company reduce its Ebit loss (despite start-up cost of new categories and sustained investment in brand building) and it came in at R33m against R111m in Q2FY16. Overall the quarterly performance was amidst a sluggish demand environment, but most major categories recorded an improvement in market standing. This segment saw an improvement driven by enhanced scale and enriched mix. Company saw improvement despite significant increase in input cost, gestation cost of new categories and sustained investment in brand building. Segment Results also include the gestation cost relating to new categories viz. Juices, Chocolates, Dairy and Health & Hygiene segment in the Personal Care Products Business.
The Branded Packaged Foods Businesses posted healthy growth in revenue led by Noodles, Staples, Snacks and Biscuits categories despite sluggish demand conditions prevailing in the industry. In the Staples, Snacks and Meals Business, ‘Aashirvaad’ atta continued to perform well consolidating its leadership position across markets. The ‘Bingo!’ range of snack foods recorded healthy growth driven by the ‘Tedhe Medhe’ and ‘Mad Angles’ sub-brands. In the Instant Noodles category, ‘YiPPee!’ continued to perform well in the market.
In the Confections Business, the ‘Sunfeast Mom’s Magic’ range of premium cookies sustained its rapid growth momentum. Portfolio premiumisation continued in the Confectionery category with the share of ‘R1 and above’ products further increasing.
The Dairy and Beverages Business scaled up sales of the ‘B Natural’ range of juices and also launched 2 exquisitely crafted blends of gourmet coffee under the ‘Sunbean’ brand. During the quarter, the Business expanded the footprint of ‘Fabelle Chocolate Boutiques’ to ITC Sonar, Kolkata, ITC Maurya, New Delhi and ITC Grand Chola, Chennai.
The Personal Care Products Business continued to focus on product mix enrichment and augmenting its product portfolio. Recently launched variants in the Hand Wash and Antiseptic Liquid categories under the ‘Savlon’ brand continue to gain traction.