ITC Rating: Buy – Status quo on tax is a positive for firm

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September 21, 2021 1:45 AM

Cigarette volumes likely to recover in coming quarters; valuations are attractive; TP raised to `300; stock is a high conviction ‘Buy’

Bingo wafers, made by ITC Ltd., sit for sale at a shop in Mumbai, India, on Sunday, Jan. 6, 2008. Credit Suisse Group raised its share-price estimate for ITC Ltd., India's biggest cigarette maker to 242 rupees from 194 rupees. Photographer: Adeel Halim/Bloomberg News

The GST Council made a series of changes in GST rates, incl. some major announcements, at its meeting on Friday. The Council however made no rate change in any of the cess sectors, including tobacco. This is a positive development for ITC, which is also set to see a recovery in cigarette volumes & earnings in the coming quarters. Valuations are attractive and stock offers c.5% yield. We retain our high conviction Buy with revised Rs 300 PT (up from Rs 275).

Stable tobacco tax: GST Council made a series of changes in the GST rates and also deliberated on the issue of compensation cess and noted that the cess would have to be levied beyond June-22 until Mar-2026 to service the revenue shortfalls for states during FY21/ FY22. Compensation cess on tobacco remains steady.

Cig. recovery: With stable taxation & tailwinds from economy opening up, cig. volumes are likely to see a recovery in the coming quarters. Even in Q1FY22, impact of the second wave was lower vs. last year, and recovery has been strong since mid-Jun’21. As mobility further picks up, volumes are likely to rise sequentially. This should drive strong growth in cigarette Ebit and we forecast >15% y-o-y in FY22.

FMCG to moderate: FMCG benefited from higher demand for packaged foods, health & hygiene products in FY21. On this high base, growth rates are likely to moderate to single-digits on a LFL basis in FY22. Margin expansion is also expected to take a pause given high input inflation. Nonetheless, over FY21-24e, FMCG Ebit is likely to grow at a robust 20% Cagr.

Hotels recovering: ITC saw an Ebit loss of Rs 5.3 bn (3-4% of overall Ebit) in its hotels business in FY21 due to Covid. Despite second wave impact, the trend has been far better in Q1FY22. With travel recovering and continued cost focus, we expect the business to get to Ebit break-even in H2FY22.

Others: Paperboards business has also seen a strong recovery in Q1 (rev. +54%), after a 8% revenue decline in FY21. Further, high pulp prices have led to higher realisations on paper products, even as backward integration has contained input costs. We expect a strong 50% growth in paperboards Ebit in FY22.

12% EPS Cagr: Overall, we expect ITC to see strong acceleration in earning growth led by the cigarette business. EPS growth is likely to be in double-digits in both FY22 and FY23 and we forecast a 12% Cagr over FY21-24e.
5% dividend yield, valuations attractive: ITC paid out a dividend of `10.75 in FY21, implying a >100% payout ratio. Despite a 9% EPS decline, DPS was up 6% y-o-y. Dividend pay-outs are likely to stay high and on our estimates, the stock builds in a 5% yield at CMP and trades at 17x FY23e EPS, a discount to five-year average at a time when consumer stocks are trading at a premium.

High conviction Buy: We retain our EPS estimates and roll over valuation multiples to Sep-23. We also increase our target PE for the cigarette business to 16x (15x earlier) and for the FMCG business to 4.5x EV/ Sales (vs. 4x earlier). We maintain a high conviction Buy on ITC.

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