Despite a weak macro climate, we believe the cigarette business will deliver flat volume growth. ITC Ltd has taken a cumulative price increase of ~18.5% from May’14. We estimate ~16% of this price increase was taken around May’13 as they passed through the excise duty increase and VAT increases announced by various state governments. The GoldFlake family — King-size and Regular filters — have taken up prices in Q2FY14 (~2.5% on a weighted average basis) which could keep volumes down in Q2FY14, recovering only in 2HFY14E. Q1FY14 volume decline was ~1.5-2% on a year-on year basis.
We estimate flat volumes in FY14E as volume growth is expected to recover in 2HFY14E. A worse-than-expected macro situation could delay this volume recovery; but this is not our base case assumption. The volume growth for ITC’s cigarette business is the key data-point to watch.
Margins in the cigarette business in Q1FY14 were ~32.6% (vs FY13 at 32%) which shows a positive trend. We expect margins in FY14 to expand ~50bps averaging at ~32.5% for 2013.We maintain Buy with a price target of R400. We derive our target from a DCF-based methodology and explicitly forecast long-term valuation drivers using UBS’s VCAM tool (assuming an 11.4% weighted average cost of capital).