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ITC: Tough times ahead - Views on News from Equitymaster

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ITC: Tough times ahead
Jan 19, 2009

Performance summary
  • Topline grows by 10% YoY during 3QFY09 and by 15% YoY in 9mFY09.
  • Operating margins drop from 35.8% in 3QFY08 to 35.7% in 3QFY09. For the 9 month period they drop from 34.4% in 9mFY08 to 32.2% in 9mFY09.
  • Lower margins coupled with higher interest expenses and lower other income restricts the bottomline growth to 4% YoY during the quarter.


Standalone financial snapshot
(Rs m) 3QFY08 3QFY09 Change 9mFY08 9mFY09 Change
Net sales 35,064 38,587 10.0% 101,394 116,553 15.0%
Expenditure 22,495 24,806 10.3% 66,539 79,005 18.7%
Operating profit (EBDITA) 12,569 13,780 9.6% 34,856 37,549 7.7%
EBDITA margin (%) 35.8% 35.7%   34.4% 32.2%  
Other income 802 976 21.7% 3,209 2,881 -10.2%
Interest 18 5 -75.4% 19 46 142.9%
Depreciation 1,097 1,442 31.4% 3,170 4,043 27.6%
Profit before tax 12,255 13,310 8.6% 34,876 36,340 4.2%
Tax 3,948 4,277 8.3% 11,032 11,794 6.9%
Profit after tax/(loss) 8,307 9,032 8.7% 23,845 24,546 2.9%
Net profit margin (%) 23.7% 23.4%   23.5% 21.1%  
No. of shares (m)       3,766 3,772  
Diluted earnings per share (Rs)*         8.5  
Price to earnings ratio (x)         20.3  
* On a trailing 12-m basis

What has driven performance in 3QFY09?
  • ITC reported a topline growth of 10% YoY during 3QFY09, while sales were higher at 15% YoY during 9mFY09. Higher Paperboard & Packaging revenues and superior product mix in cigarettes offset the impact of a sharp slowdown in the hotels business. While cigarette revenues jumped 18% YoY during the quarter, volumes declined by 3.5% YoY. Recent implementation of smoking ban in public places and migration from non- filter to filter cigarettes had some negative impact. Paperboard segment revenues increased 14% YoY during 3QFY09 on account of new capacities.

    Revenue Mix
    (%of net sales) 3QFY08 3QFY09 9mFY08 9mFY09
    Cigarettes 44.1% 47.4% 41.7% 40.5%
    Others 16.8% 17.1% 15.1% 15.9%
    Total FMCG 60.9% 64.5% 56.8% 56.4%
    Hotels 7.5% 5.9% 6.0% 5.2%
    Paperboards, paper & packaging 14.4% 14.9% 13.5% 14.1%
    Agri business 17.3% 14.8% 23.7% 24.3%
    Total turnover 100.0% 100.0% 100.0% 100.0%

  • The hotel segment witnessed tough times with both occupancies and room rates sliding due to the recent crisis faced by the sector. The agri segment also underperformed due to rationalisation of the agri-commodity portfolio. Sales growth in the branded packaged foods business was modest in the face of economic slowdown and its impact on urban demand in certain categories. The sales are lower than our estimates.

  • While the operating margins during the quarter were stable, during 9mFY09 they declined by 2.2%. Higher staff and other expenses led to the decline. The company is heavily investing in marketing and brand building activity for its FMCG segment. Higher store rentals and investment in increasing distribution and infrastructure network further added to the costs.

    PBIT margin trend…
    (% of segmental revenues) 3QFY08 3QFY09 9mFY08 9mFY09
    Cigarettes 56.8% 56.9% 56.4% 55.9%
    Others -10.0% -17.6% -8.2% -16.9%
    Total FMCG 38.3% 37.1% 39.2% 35.5%
    Hotels 47.9% 36.9% 38.3% 34.3%
    Paperboards, paper & packaging 21.4% 17.7% 20.8% 18.4%
    Agri business 4.2% 8.1% 3.3% 6.1%
    Total PBIT 30.7% 29.9% 28.1% 25.9%

  • On the segmental PBIT front, the profits of the cigarette division increased by 18% YoY and 12% YoY respectively for both the periods under consideration. The growth was mainly driven by price hikes and product mix improvement. Agri business also reported improvement in margins on account of rationalisation of the agri-commodity portfolio and a spurt in leaf tobacco prices. On the flipside, paperboard segment and hotel segment witnessed a decline. While higher input cost and depreciation (capacity increment in the pulp and paper machine facilities) affected the margins in paperboard segment, economic slowdown and terror attacks affected the performance of the latter. The company continues to suffer losses in the non cigarette division. The losses were higher by 97% YoY and 151% YoY respectively for both the periods under consideration. Losses from the segment continue to be at peak levels due to high-cost inventories, sustained brand building costs for personal care segment and slow growth in foods.

  • Profits during 3QFY09 increased by 8.7% YoY. However, during 9mFY09, the profits witnessed a muted growth of 2.9% YoY. Lower margins, lower other income, higher interest and depreciation costs led to the slow growth. The performance is lower than our estimates.

What to expect?
    At the current price of Rs 170, the stock is trading at a price to earnings multiple of 14.9 times our FY11 estimates. The company’s performance during the quarter was a mixed one. While its main revenue earner (cigarette division) performed well, cyclical segments and FMCG segment continue to worry. For its non cigarette divisions, on one hand ITC is facing a slowdown in urban demand, while on the other hand the company is making huge investments in brand building and expansions. Though the performance of the hotel segment would be better in the coming quarter, the pressure would continue. Construction activity at Bangalore and Chennai continues to progress satisfactorily. The company has plans to invest a whopping Rs 200 bn towards its various businesses over a period of five years starting FY08. We do not expect the returns from this capex to accruing immediately. On account of all these factors, we believe the risk-reward ratio is skewed towards the former and hence our negative outlook towards the stock over the medium term.

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