In-line cigarettes results; share price fall overdone Although ITC’s overall sales in Q2FY16 were 6% lower than our estimates, the all-important cigarettes net sales (Rs 43.2 bn, up 2% y-o-y) and Ebit (Rs 29.7 bn, up 3% y-o-y) were in line with our estimates. We believe cigarette volumes for the quarter declined by 14-15% y-o-y. The share price decline of ~5% after the results was largely due to consensus’ misplaced optimism of 8-9% y-o-y Ebit (earnings before interest and taxes) growth for the quarter. Based on our recent channel checks, we expect flat y-o-y cigarette volumes and cigarette Ebit growth of 11-12% y-o-y for 2HFY16. We expect cigarette volume CAGR (compound annual growth rate) of 3%, with overall sales/EPS CAGR of 14% over FY15-20e. At 22x FY17e P/E (price-to-earnings ratio), the stock is trading at a steep 35% discount to staples firms like HUL. The more than 15% excise hikes announced over the past five years has had an unsustainable impact of rapid rise in illegal cigarette consumption, decline in government’s tax collections and increase in chewing tobacco consumption. We reiterate BUY, with TP (target price) of R405 (21% upside).
Cigarette business reports in-line performance
ITC reported net sales of R85 bn (down 1% y-o-y), 6% below our estimate. Cigarette net sales increased 2% y-o-y, implying a cigarette volume decline of 14-15% y-o-y. Other FMCG sales growth of only 7% y-o-y was disappointing vs our expectation of 11% y-o-y growth. Gross margin expanded 325bps y-o-y to 63.9%, due to lower prices of tobacco in the Cigarette and Agri-business. This was partially offset by higher employee cost and other expense, resulting in Ebitda margin expansion of 132bps y-o-y to 40%.
Cigarettes—Volume growth impacted by increasing prevalence of illegal cigarettes. ITC reported cigarette net sales growth of 2% y-o-y, implying cigarette volume decline of 14-15% y-o-y. Whilst legal cigarette volumes have remained flat over FY10-14, illegal cigarette volumes have expanded at a CAGR of 10% over the same period and hence their proportion has increased from ~10% in FY05 to 14% in FY10 and ~20% in FY14.
Other FMCG–Maintains steady pace of topline growth
The non-cigarette FMCG business grew net sales by only 7% y-o-y; excluding the impact of weak noodles sales, net sales grew 10% y-o-y. Aashirvaad atta and Bingo snack foods and Mom’s Magic continued to perform well.
The hotels business delivered sales growth of 11% y-o-y due to better room occupancy rate and strong growth in the F&B segment. However, profitability was impacted by lower room rates, due to surplus room inventory.
Agri business: Revenue was impacted by lack of wheat, soya and coffee exports.
Paperboards, Paper & Packaging: Sales growth in this segment was impacted by lower FMCG and cigarette category sales.
Sanjiv Puri–The possible successor to YCD?
With the appointment of Sanjiv Puri to the board following the retirement of Kush Grant and Mr Dhobale, ITC seems to be working towards a succession plan for YC Deveshwar (YCD). Sanjiv Puri, currently the President of the FMCG business, seems to be the front-runner to succeed YCD in case the Chairman retires in 2017.
At CMP of R334/share, the market ascribes ~R235/share to the cigarette business. Our reverse-DCF for the cigarettes business suggests that this valuation factors in -5%/15% volume/excise duty CAGR over FY15-20. With more positive catalysts from H2FY16, the weak Q2FY16 results will be a good entry point into the stock.