Neutral rating on ITC; Taxes burn a hole

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Updated: August 12, 2016 1:31:59 PM

Cigarette volume growth flags, FMCG, hotel grow in double digits

ITC posted weak Q4 performance with net sales, Ebitda (earnings before interest taxes depreciation and amortisation), and adjusted PAT (profit after tax) growth of 1%, 3%, and 6%, respectively. Subdued growth for the cigarette division led the disappointment. While sharp under-perfor- mance since the budget announcement limits downside, we think uncertainties related to cigarette demand elasticity and earnings after four consecutive years  of high taxation may continue to weigh on stock multiples in the near term. We reduce our FY16/17 EPS estimates by 3%. We stay Neutral with a new Mar-16 PT (price target) of Rs 360.

Cigarettes –volume challenges sustained: The cigarette segment posted 3% net sales growth and 6% Ebit growth. We estimate the volume decline to be 12-13%, affected by the steep price hikes. Four consecutive years of sharp price increases have affected cigarette demand elasticity,.  resulting in less smoking frequency and rising illicit trade share. Price increases have been higher than needed to offset the tax impact, although higher sales & distribution related expenses led to 170 basis point year-on-year expansion in Ebit margins. We estimate a 9% volume decline in FY16 with H1 faring worse than H2.

Other FMCG and Hotels – in-line: The other FMCG segment registered net sales and Ebit growth of 11% and 13%, respectively, in Q4. Apparel and biscuits witnessed sluggish growth. The hotels division posted revenue growth of 8% and Ebit margin of 12% in Q4. A weak pricing environment and gestation costs for new properties in Bangalore and Gurgaon continue to weigh on operating performance. We expect profitability for other FMCG and hotels division to improve in FY16.

Agri and Paper– lower than expected: For the agri division, revenue decreased by 29% y-o-y due to lack of trading opportunities; however, an improved mix (higher share of leaf tobacco) supported Ebit growth of 13% y-o-y. Lower offtake by cigarette and FMCG industry led to sluggish sales growth (-5% y-o-y) and flat Ebit growth for the paper division.

Other highlights

(i) Dividend of R6.25 per share implied a payout of 52% (versus  55% in the previous year).
(ii) Capex in FY15 amounted to R30 bn including purchase of Goa Hotel property (for R5.2 bn) and acquisition of FMCG brands (Savlon, Shower & Shower and
(iii) Expenses in Q4 included one-time cost of R580 million for the rationalisation of safety match operations.

Cigarette division: Aggressive cigarette taxation weighed on volumes which saw a 12-13% de-growth in Q4, we estimate. Value growth was 3%. While Ebit growth of 6% was supported by price increases, it was nevertheless lower than our estimate and growth moderated on a sequential basis.

Other FMCG: In Q4, the other FMCG division posted revenue and Ebit growth of 11% and 13%. Demand in the packaged foods industry was subdued. While well penetrated categories such as biscuits and confectionary witnessed moderate growth, the noodles segment grew ahead of the industry average. However, ITC continued to invest in the business with new product launches. Start-up costs of two new categories (fruit juices and gums), scale-up costs of deodorants (launched in 2013), and investments behind other new product launches (under existing brands) weighed on margins.

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