The new dividend policy has hiked the guided payout ratio to 80-85% from c.70% currently. We model Rs 20 dividend in May 2020 (including Rs 10 special dividend). We note similar hikes in 2004 and 2010, which resulted in significant stock rerating. With this payout increase, ITC addresses an important investor concern of capital allocation – particularly Hotels capex (which has mostly been EVA negative). Some investors also expect a share buyback – we assign low probability for this. We reckon consensus may now potentially anticipate corporate actions as further upside triggers (like FMCG demerger, etc). We expect ITC stock to rerate (yield + growth) – note that cigarettes business now trades at 9x 1-year forward P/E, even cheaper than global tobacco. ‘Buy’
ITC’s revised dividend distribution policy guides to an increase in dividend payout to 80-85% from 65-70% currently and is applicable from FY20 onwards. We note that, in previous two occasions of dividend payout step jump (in 2004 and 2010), ITC witnessed significant stock rerating. The higher dividend distribution also addresses investor concerns of capital allocation – particularly to hotels. We also note the low capital requirement in the medium-term – recently commissioned three new hotels and has added manufacturing lines for its FMCG business. The corporate tax rate cut (in Sep’19) also further increases the cash available for disbursement. A share buyback, in our opinion, is a low probability event.
We believe that the price hike, impact is more manageable in the current environment given the higher inflation (5% in YTDFY20). ITC’s lower share of DSFT (40%) versus peers (c.70%) means is it better equipped to benefit from mix improvement to RSFT segment. Contrary to consensus belief, in our view, product price changes impacting coinage does not affect volumes as the consumer purchases more than one cigarette in a single transaction.
Our earnings estimates are broadly unchanged – we only adjust for higher dividend payment; modelling revenue/ Ebitda/ PAT CAGR of 9/8/5(%) respectively over FY20-22E. Maintain ‘buy’ with a DCF-based target price unchanged at `220. At our target price, the stock will trade at 15x P/E multiple Mar’22E. Key downside risk is tax hikes much ahead of inflation.