ITC: Built On A Solid Footing

The fast moving consumer goods (FMCG) sector is the fourth largest in the Indian economy and provides employment to around three million people, accounting for approximately five per cent of the total factory employment in the country. Steady economic growth, rising share of organised retail, improving awareness and a favourable demographic dividend will give a boost to the industry's growth.

India's FMCG market is expected to more than double to USD 104 billion by 2020 from the present level of USD 49 billion, as per a research report published by Assocham-TechSci Research. The Indian government’s measures such as Goods and Services Tax Bill, Food Security Bill and increased limit of foreign direct investment in industries such as food processing and warehousing logistics will have a positive impact on the FMCG sector.

However, when seen in the global context, India only accounts for a mere 0.68 per cent of the global FMCG market. Many foreign FMCG multinationals have established themselves in India, but desi companies such as ITC has given them formidable competition, despite being one of the late entrants in the food industry.

About Company

ITC is one of the most admired and valuable companies with a market capitalisation of over Rs 3 lakh crore. The company’s business spreads the length and breadth of the country, spanning all the three sectors of the economy - agriculture, manufacturing and services – and its businesses make a unique contribution to the economy. ITC’s aspiration to create enduring value for the nation and its stakeholders is manifest in its robust portfolio of traditional and greenfield businesses encompassing consumer goods, hotels, paperboards and specialty papers, packaging, agri-business and information technology. The company pursues societal initiatives that stand at the forefront of ITC’s core business strategy, thus creating a sustainable and profitable future for all the stakeholders.

The company is an undisputed leader in cigarettes with market leadership across all segments- geographic and pricing. The cigarette business continues to remains the cash cow for ITC as it contributes close to 63 per cent of total revenues, as of quarter ending September 30, 2016. The company’s cigarette volume growth has been moderating since the last eight quarters, hampered primarily due to various taxes being imposed by the government along with mushrooming illegal contraband cigarette brands eating into legitimate revenue of the company. The plight has been so severe that over the last 4 years, excise duty has increased by 118 per cent and VAT by 142 per cent on per unit level cumulatively. India is fourth largest illegal cigarette market in the world which constantly keeps legal cigarette industry’s volumes remain under pressure.

Recently the company had hiked prices of 69 mm and 74 mm cigarettes by 14-15 per cent, which will help augment margins going forward as this segment contributes 30 per cent of the total cigarette volumes.

Industry experts and analysts expect the company to report good third quarter earnings on the back of gains in the market share post demonetisation, which negatively impacted the sales of contraband cigarettes due to cash crunch situation. But, over the short term, overhang remains on the company pertaining to the taxation structure under GST. However, inelastic demand as far as the cigarette consumption goes bodes positive for the company.

ITC’s FMCG business has been seen taking tremendous strides over the past years with double digit growth and contributing around 20 per cent to company’s total turnover. Improvement in the profitability of other FMCG segments, aided by enhanced scale and improved category mix, despite rising input costs and gestation cost of new categories. The company has built top brands in the name of Aashirvad (Rs 3,000 crore), Sunfeast (Rs 2,500 crore) and the combined Classmate and Bingo (Rs 1,000 crore). The company has a diversified portfolio of offerings in the branded packaged foods segment with interest ranging from biscuits, snacks, noodles, confectionery, dairy, etc.

Agriculture business is an important part of ITC as the business provides strategic sourcing to support company’s cigarette business and leverages its deep rural linkages to source for its food business, making it a truly backward integrated business. Agriculture business adds close to 14 per cent in revenues of the company, which slowed in the recent quarter (Q2) as it merely grew by 2 per cent on the back of higher agri-commodity sales in the domestic market. Agriculture business is expected to be supportive on the back of good rains in the country.

Paperboards, paper & packaging

The paper business largely provides packaging solutions to the cigarettes and new FMCG businesses around the country. ITC’s paper business is the leading supplier to Indian FMCG industry and is the most profitable amongst the paper companies in the country. The segment impacted by subdued demand on account of slowdown in FMCG and pressure on legal cigarette industry. Paper business adds close to 10 per cent to total revenues. Paper board business is all set to address suitable opportunities in the stationery market with government’s special emphasis on food packaging and education sector. The industry’s growth driven by increasing literacy and enhanced level of government spending and public-private initiatives in education will be a booster for ITC.

ITC has the country’s premier chain of luxury hotels, which has become synonymous with Indian hospitality. ITC operates close to 100 properties across 71 locations. Revenue addition on the part of hotel business is not significant at this point of time. However, going forward, as economic conditions and infrastructure improve, leisure tourism and business-related travel is also projected to grow faster in India. Thus, ITC’s hotels business will continue to be one of the fastest growing hospitality chains in India. The company has been making ongoing investments in hotels business. Recently, the company started working on the construction of a 300-room luxury hotel named ‘ITC Narmada’.

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Financials

On the financial front, ITC is performing exceptionally well with revenue CAGR of 9.80 per cent over the last five years, led by strong showing across segments, especially with respect to cigarette and FMCG business. During the same period, the company’s EBITDA CAGR grew by a strong 11.70 per cent due to good operational performance on the part of tobacco and non-cigarette segments, which grew despite weak demand market environment. With the courtesy of solid sales and EBITDA performance of the company, ITC could sustain its margin run rate for the period between FY12-FY16. However, when it comes to profitability, the company’s PAT grew by close to 11 per cent CAGR over the last five years. Nevertheless, ITC remains on a strong footing when it comes to profitability, given the business prospects of individual segments and the future outlook.

On a quarterly basis, ITC reported a steady performance despite a challenging market environment with continuing pressure posed by the illegal cigarette industry and overall muted demand prevailing in the FMCG industry. The revenue from operations for Q2FY17 stood at Rs 13,616.61 crore, representing a growth of 8 per cent as compared to Rs 12,611.29 crore in the corresponding period of the previous fiscal. The consolidated EBITDA for the quarter ending September 30 grew by a steady 7.6 per cent at Rs 3361.59 crore vis-a-vis Rs 3124.52 crore achieved in the same quarter of last fiscal. However, the margin for the quarter largely remained flat on a yearly basis at 26.7 per cent. The profit after tax increased 10.50 per cent in Q2FY17 at Rs 2,500.03 crore, as compared to Rs 2262.50 crore in the corresponding quarter of the previous fiscal.

Looking at the Q2FY17 revenue breakup, the cigarette business contributed around 63 per cent of total revenue earned for the company. FMCG consisting of packaged food added another 20 per cent to company’s revenue pie. Agriculture and paper business contributed close 14 and 10 per cent, respectively, to ITC’s revenue. Over the years, the company has been trying to diversify its revenue base to de-risk its overall business.

Conclusion

ITC remains one of the best companies to drive the next wave of economic growth, The company’s strategy of diversifying into newer categories of businesses along with special thrust on the FMCG business augurs well for the company as it will not be totally dependent on few revenue streams which at times becomes the impediment for future growth and visibility. The company has recorded strong financial performance across its varied businesses, supported by volume growth which has reflected in the dividend yield of 2.3 per cent in comparison to its closest rival Godfrey Phillips which has a dividend yield of 0.75 per cent, indicating strong pay-out to its shareholders. The key risk pertaining to the GST taxation on cigarette remains an overhang on the company. However, ITC’s dominance in cigarette segment along with thrust on FMCG portfolio will provide a perfect platform for the company to grow. From a risk-reward point of view too ITC looks attractively priced and trades at a discount as compared to its peers. Therefore, we advise all our readers and client to ’BUY’ ITC.

"ITC stock is the cheapest amongst the FMCG basket trading at 24-25x P/E FY18E compared to the average FMCG basket at 32x. However, now comparative environment is becoming little better for the cigarette companies, considering that the government now is also focusing on regulation on entire tobacco products (including beedis, chewing tobacco, etc) and not just cigarettes. Demonetisation impacted the short-term growth for consumer companies, but ITC is expected to be impacted lesser because the category is largely inelastic and illegal cigarettes (one fifth of total cigarette market) have seen significant impact due to demonetization being largely cash dependent. The budget is expected to be reasonable (~8-10% hike expected) like last year’s budget. The government has seen dip in excise collection from cigarettes due to sharp duty hikes. This year excise duty collection against budgeted is in comfortable range - till date excise duty collection has been highest compared to budgeted in the last four years and hence it gives all the more reason for a reasonable duty hike."

-Abneesh Roy & Tanmay Sharma
Senior Vice President andFMCG, Retail & Media Analyst, Edelweiss Financial Services

"We have analysed scenarios for tax structures for ITC in the light of the uncertainty related to impact of GST roll-out. We believe GST at 40 per cent is a negative but not a disaster, as long as excise duty is kept unchanged in the same year. However, if excise duty is also increased by 10 per cent or more around the same time, we believe ITC could give no returns for maybe two years. The scenarios where GST rate is 26 per cent or a partial excise refund is given to offset the hike due to GST would be treated as a positive surprise and the stock could give 25 per cent returns in these cases. The stock currently yields single-digit returns based on weighted average probabilities of scenarios"

-Percy Panthaki
Analyst, IIFL Institutional Equities