Rating: add; ITC – Good progress across businesses

ITC has been successful in gaining market share in the Indian cigarette market in part due to its ability to compete with illegal and organised players in the industry. The modest 2-2.5% increase in overall tax on cigarettes in the recent budget paves way for balanced revenue growth (volume + pricing) and further share gains from illicit trade. The FMCG segment is tracking well and can continue to deliver margin expansion of 100-150 bps/year for another 3-5 years in our view. The Paperboards and Hotels segment’s margins are likely to settle well above the pre-pandemic level, even as it moderates from current peak levels. The company’s EPS will grow by 11% in FY2024e. This double-digit (DD) growth can continue as long as there is a stable tax regime and some measures are taken to clamp down on illicit trade.

Cigarettes: On track to deliver DD revenue/Ebit growth in FY2024E: The stable tax regime over the past three years has helped ITC gain share from illicit trade and recoup some volumes lost to disruptions. Furthermore, ITC’s execution, product innovation, rural distribution expansion and actions by enforcement agencies have helped. Consequently, ITC’s cigarette volume CAGR (3-yr) improved to 6.3% (KIE estimate) in Q3FY23. The measured tax increase in the recent budget would allow ITC to drive revenue growth through a balance of volume growth and pricing; we note that ITC has taken a 2% price increase at the portfolio level. We model 7%/ 11%/13% volume/revenue/Ebit growth in the cigarette segment in FY2024E, assuming a 4% price increase. DD Ebit growth can sustain beyond FY2024E, so long as the stable tax regime and deterrent actions by enforcement agencies continue.

FMCG: Robust growth with 100-150 bps expansion: ITC’s FMCG segment’s 3-year revenue CAGR for 9MFY23 stood at 14%, ahead of the industry. The company has achieved scale in the FMCG business and leadership position in several categories through its differentiated play. ITC is selective about the segments it plays in the personal care segment. Aashirvaad has a double digit Ebitda margin business. Going ahead, the focus for the brand lies in expanding to adjacencies. The Ebitda margin expansion over the past five years stood at an average of 100 bps annually.

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ITC has gained 100-150 bps market share in Cigarettes: ITC’s market share gains from both organised and illicit trade over the past 2-3 years were driven by a stable and supportive taxation regime over the past 2-3 years, innovations to drive premiumisation and introductions to address consumer needs, increased presence in rural India, better execution, and improved visibility at point of sale. According to industry estimates, illicit trade is pegged at 25% of the total cigarette industry volumes. Illicit trade stood to benefit from excise duty hikes, whereas the legal industry took the brunt; it operates in both the premium and economy segments and the mix is 60:40.

We estimate 7% volume growth in FY2024E, led by (i) modest increase in tax in the recent budget, (ii) growth momentum that the segment has been witnessing off-late and (iii) some clamp down on illicit trade by enforcement agencies.

FMCG business

ITC managed to scale its FMCG business to Rs 42 bn in 9MFY23, supported by its dominating presence in segments such as Atta–ITC’s Aashirvaad commands 40% market share, biscuits–market leader in the premium cream segments, noodles –commands a stable 20% market share; Nestle’s share loss in noodles in the recent quarter, led by a steep price increase, is ITC’s gain, education stationery products–market leadership position, and personal care–pole position in differentiated areas such as liquids (hand and body washes).

ITC has the right-to-win in the foods segment, but the personal care segment remains slightly weak due to higher competitive intensity and its selective approach to the areas they play. We expect ITC to focus on expanding the brand to adjacencies going forward—under Aashirvaad brand, ITC has presence in salt, spices (along with Sunrise), dairy, vermicelli, and others. Other areas of brand extension are besan, suji and more.

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Paperboards and Hotels

The Paperboards segment delivered robust results, driven by industrywide tailwinds in the past 12- 18 months due to a significant increase in pulp prices caused by global supply chain disruptions. These tailwinds are now moderating toward end-3QFY23. ITC remains competitively better positioned due to their inhouse capabilities for manufacturing pulp, fiber sourcing being close to mills, and implementation of various efficiency-related initiatives such as Industry 4.0.

Hotels reported a solid Q3, with overall revenue for 9MFY23 up 31% over 9MFY20. Ebitda margin expansion of 800-900 bps for 9MFY23 over 9MFY20 was due to higher RevPAR, operating leverage, and structural cost interventions.