In our downgrade note ITC - Heading into a period of slower growth, we highlighted how consistent and large price increases...
In our downgrade note ITC – Heading into a period of slower growth, we highlighted how consistent and large price increases have meant a sharp drop in volumes for the cigarette business; we are building in a 5% decline in volumes and 10% EBIT growth.
We believe there could be downside risk to our FY16F volume growth assumptions. In Q3FY15, ITC saw a double-digit decline in volumes on a y-o-y basis, which was the result of consistent and large price increases taken in a short space of time. Given the 15% reported blended price increase is ahead of what the company would have required to offset the excise duty increase, we may see some EBIT margin improvement in FY16.
However, the big caveat here is that volumes remain largely constant, which we believe is unlikely to be the case. The trend seen in Q2 and Q3FY15 are more indicative of the medium term, which is what we are building into our numbers. Hence overall, we do not see a significant risk to our estimates of ~10% EBIT growth in the cigarette business in FY16F. Re-rating is unlikely. We cut our long-term multiple for the cigarette business to 20x as we believe slower growth would result in a lower multiple. As well, regulatory risks will continue to keep multiple expansions in check.
We think ITC has entered into a period of slower growth and unless there is a change in the way the GoI perceives the sector, we believe the stock will remain a sector underperformer in the near term. ITC’s other businesses added substantial revenue diversification but have not moved the needle on profits with cigarettes continuing to contribute 85% of profits. We retain our neutral rating.