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Reiterate Buy as one of the top picks for 2014: ITC Ltd has underperformed both the Sensex and FMCG index since July. The underperformance has not been driven by changes to the company’s earnings profile, but by a sharp correction in valuation multiples. However, we believe at current valuations, ITC’s discount to large caps such as Hindustan Unilever (HUL) and Nestle is significantly above long-term averages. We continue to believe ITC will deliver mid-teens Ebit (earnings before interest and taxes) growth in the cigarette business over the next three years, which should drive solid stock price performance from current levels. We think the recent underperformance is a great opportunity to add the stock to portfolios. We reiterate our Buy with a TP of R392—we view ITC as a key consumer stock to own into 2014.
Steady performance in cigarettes business: One of the biggest surprises over the past few quarters has been the consistent performance of ITC’s non-cigarettes FMCG business, which has delivered consistent 20%+ revenue growth. Sustained growth of the business combined with improving profitability will be a key catalyst. The cigarettes business continues to be steady and is likely to again deliver in FY14F (forecast). Volume growth in the cigarette business, which was negative in Q2FY14, should reverse into H2, which should also be a positive catalyst.
Performance in line with sector average on a YTD basis: ITC’s performance so far this year has been largely in line with the FMCG index (ITC +7%, vs. FMCG index +7%). Given the strong run the stock has had since January 2011 (ITC +69%, Sensex +2%), YTD (year-to-date) performance has been modest. The stock has seen a 18% correction since 23 July 2013, vs. the Sensex up +3% in the same time period. It has also underperformed the FMCG index by 2%.
Operational performance has continued to be strong: The company has continued to deliver strong operational performance over the past few years, with cigarette business being the key growth driver for profits. Over the last five years, operating profits for the company have grown at an average of 19%, which is among the highest in the sector. Additionally, a large part of this has been driven by cigarettes, with contributions from other business to operating profits still under 20%.
Cigarette business on a strong footing: As with previous years, the company has been able to deliver strong Ebit growth in the