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ITC: Riding strong! - Views on News from Equitymaster
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ITC: Riding strong!
Jan 20, 2006

Performance Summary
Tobacco major, ITC, reported a splendid performance for the December quarter, with a near 38% YoY growth in net sales. However, higher raw material costs put pressure on margins, which consequently shrank by 360 basis points, clubbed with an extraordinary expense, led to a much slower growth in bottomline. Barring the one-time extraordinary effect, bottomline has grown by a respectable 25% YoY. It must be noted that the company has embarked on a conscious move to de-risk its revenue model by increasing the share of its other businesses in its total revenue pie, glimpses of which were visible again in this quarter.

(Rs m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Gross Sales 33,141 42,391 27.9% 99,917 120,159 20.3%
Net Sales 18,591 25,560 37.5% 54,623 70,061 28.3%
Expenditure 11,525 16,777 45.6% 33,330 44,811 34.4%
Operating Profit (EBDIT) 7,066 8,783 24.3% 21,293 25,249 18.6%
Operating Profit Margin (%) 38.0% 34.4%   39.0% 36.0%  
Other Income 520 489 -6.0% 1,765 2,115 19.8%
Interest (net) 182 15 -91.7% 412 23 -94.5%
Depreciation 750 831 10.8% 2,231 2,462 10.3%
Profit before Tax 6,654 8,426 26.6% 20,415 24,880 21.9%
Tax 1,987 2,603 31.0% 6,219 7,751 24.6%
Extraordinary income/(expense) - (454)   - (454)  
Profit after Tax/(Loss) 4,667 5,368 15.0% 14,197 16,675 17.5%
Net profit margin (%) 25.1% 21.0%   26.0% 23.8%  
Effective tax rate (%) 29.9% 30.9%   30.5% 31.2%  
No. of Shares (m) 3,734 3,755   3,734 3,755  
Diluted Earnings per share (Rs)*         6.5  
P/E Ratio (x)         22.6  
*trailing 12 months            

What is the company’s business?
ITC commands about 70% of India’s Rs 120 bn domestic cigarette market (value terms). Out of the top 10 brands in India, 6 belong to ITC. The growing awareness on harmful effects of tobacco as well as the government’s punitive tax policy forced ITC to move towards de-risking its revenue profile. Consequently, it merged the paperboards subsidiary with itself and invested in growing the hospitality, retailing, packaged foods and IT businesses. The ITC group has emerged as the second largest luxury hotel chain after Indian Hotels. In packaged foods, its product range includes ready to eat (Kitchens of India), staples (Aashirvaad Atta and Salt), confectionery (Mint-O and Candyman) and biscuits. ITC has also entered into garment retailing and has 42 Wills Lifestyle stores. Other initiatives include greeting cards (20% market share), safety matches and incense sticks.

What has driven performance in 3QFY06?
Core business sustains momentum: Despite operating in a challenging environment, due to severe restrictions on advertisement and communication, along with an excise duty hike of 10% on cigarettes in March 2005, the company reported an applaudable growth of over 19% YoY during the quarter. Cigarettes continue to be the mainstay of the company and contributes around 83% of the company’s PBIT.

(as % of gross sales) 3QFY05 3QFY06 9mFY05 9mFY06
Cigarettes 74.2% 68.8% 76.4% 71.6%
Others 4.7% 6.2% 4.0% 6.0%
Total FMCG 78.8% 75.0% 80.4% 77.6%
Hotels 5.1% 5.2% 4.0% 4.4%
Paperboards, paper & packaging 12.0% 11.7% 11.8% 12.0%
Agri business 12.3% 15.6% 12.9% 15.9%
Total turnover 108.2% 107.5% 109.0% 109.9%
Less: Inter segment revenues 8.2% 7.5% 9.0% 9.9%
Gross sales 100.0% 100.0% 100.0% 100.0%

Foods business grows, but…: ITC’s foods business continued to display brisk growth of around 85% YoY, albeit on a small base. This growth could be attributed to further launches into the confectionery category under the ‘mint-o’ brand. Also, In the biscuits category, under the 'Sunfeast' range, the company launched a couple of products like 'Sunfeast Golden Bakes' and 'Sunfeast Snacky' along with value-added products in the creams and Marie segment, which resulted in enriching the sales mix and improving realisations for the company. While this business continues to eat into the company’s profits, it must be noted that as compared to a PBIT of -27% in 3QFY05, it has come down to -15% in the current quarter.

The party continues in the hotels division: This division continues to be one of the fastest growing segments for the company. During the December quarter, this division saw a growth of over 31% YoY and margins stood at around 35% (see table below), up by 300 basis points from the previous year, due to increased room realisations and higher occupancy rates across its properties. ITC Grand Central, the company's second hotel in Mumbai, posted profits at the pre-tax level in its first nine months of operations.

Paperboard continues to score: This division clocked a 25% YoY growth during the quarter. Margins for this division are currently the highest after cigarettes and hotels. It must be noted that ITC’s paperboard unit at Bhadrachalam is the largest and amongst the most contemporary paperboards manufacturing facility in the country and accounts for over 80% of the company’s total installed paperboard capacity of 325,000 tonnes. The packaging and printing business continues to leverage its recent investments in technology upgradation to expand its range of offerings to include a wider variety of contemporary packaging formats. This has enabled the company to provide discernibly superior and innovative packaging solutions not only to the company's cigarettes business but also to the FMCG and paperboards businesses.

Segment PBIT Margins
(Rs m) 3QFY05 3QFY06 9mFY05 9mFY06
Cigarettes 23.2% 24.1% 23.0% 24.5%
Others -26.8% -15.1% -32.5% -18.3%
Total FMCG 20.2% 20.8% 20.3% 21.2%
Hotels 32.0% 35.0% 21.3% 30.8%
Paperboards, paper & packaging 19.5% 18.7% 19.6% 19.2%
Agri business 5.2% 2.3% 7.4% 4.4%
Total PBIT 19.0% 18.6% 18.7% 18.9%

Overall margins under pressure: Higher raw material costs dented margins, which is reflected as % of sales in the table below. However, other expenditure was largely under control. The lower overall margins could also be attributed to poor margins of the company’s agri business (see table above).

Cost break up
as % of sales 3QFY05 3QFY06 9mFY05 9mFY06
Material cost 35.5% 40.7% 35.0% 38.9%
Staff cost 5.7% 5.3% 5.9% 5.7%
Other exp. 20.8% 19.6% 20.2% 19.4%
Total expenses 62.0% 65.6% 61.0% 64.0%

Bottomline growth hampered: Despite a significant reduction in interest outgo, the bottomline of the company has registered a growth of 15% YoY during the quarter. While some of this cold be attributed to the lower operating margins, which has percolated down to the bottomline, an exceptional charge representing one-off assistance to contract manufactures in view of the retrospective withdrawal of Central Excise exemption on cigarettes manufactured in the North Eastern States during the year 2000. Without taking the latter into consideration, the bottomline growth has actually registered a 25% YoY growth.

Over the past few quarters…
  3QFY05 4QFY05 1QFY06 2QFY06 3QFY06
Net sales growth (YoY) 10.6% 15.7% 18.6% 25.6% 37.5%
Cigarette value growth (YoY) 5.1% 6.4% 12.0% 7.2% 19.1%
Excise as % of gross sales 44.6% 39.4% 42.8% 42.8% 39.7%
OPM (%) 37.6% 30.5% 36.5% 37.6% 34.4%
Net profit growth (YoY) 17.9% 99.3% 20.1% 17.8% 15.0%

What to expect?
At the current price of Rs 147, ITC is trading at a price to earnings multiple of 20 times our estimated FY08 earnings and market cap to gross sales of 2.8x. The merger of ITC Hotels has not only increased the company’s non-tobacco revenues, but also resulted in cost savings through better synergies. Overall, we are enthused by ITC's performance and believe that the company's non-tobacco initiatives are on track. The company remains one of our preferred plays in the FMCG sector from a two to three year perspective.

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