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ITC: Cigarettes drag down biz growth - Views on News from Equitymaster
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ITC: Cigarettes drag down biz growth
Jan 28, 2015

ITC Limited has announced its third quarter results for financial year 2014-2015 (3QFY15). The company has reported 2% YoY growth in sales and 10.5% YoY increase in net profits. Here is our analysis of the results.

Performance summary
  • For 3QFY15, revenues grew by a paltry 2.5% due to flat growth in the cigarettes biz. During 9mFY15, topline grew by 13.4%.
  • The operating margin expanded by 1.1% for 3QFY15 due to lower cost of goods sold and other expenses. For 9mFY15, the operating margin contracted by 1% YoY on account of high input costs.
  • Net profit grew by a faster 10.5% in 3QFY15 aided by a steep rise in other income. For 9mFY15, the net profit was up by 11.4%.

(Rs. m) 3QFY14 3QFY15 Change 9mFY14 9mFY15 Change
Total income 87,269 89,426 2.5% 240,001 272,146 13.4%
Expenditure 54,426 54,784 0.7% 147,486 169,842 15.2%
Operating profit (EBITDA) 32,843 34,642 5.5% 92,515 102,304 10.6%
EBITDA margin (%) 37.6% 38.7% 1.1% 38.5% 37.6% -1.0%
Other income 3,911 5,820 48.8% 8,404 11,728 39.5%
Interest  91 84 -8.4% -66 419  
Depreciation 2,259 2,376 5.2% 6,621 7,122 7.6%
Profit before tax 34,403 38,002 10.5% 94,364 106,491 12.9%
Extraordinary inc/(exp) 0 0   0 0  
Tax 10,550 11,652 10.4% 29,292 34,026 16.2%
Profit after tax/(loss) 23,853 26,350 10.5% 65,072 72,466 11.4%
Net profit margin (%) 27.3% 29.5% 2.1% 27.1% 26.6% -0.5%
No. of shares (m)         7995  
Diluted earnings per share (Rs)*         11.9  
Price to earnings ratio (x)         30.4  
* trailing 12 month earnings

What has driven performance in 3QFY15?
  • After recording double-digit growth in the previous two quarters, revenue growth slowed down to a mere 2.5% in 3QFY15. The largest segment, cigarettes, recorded a flat growth of 0.6% as sales were bogged down by steep increase in excise duty and VAT. The non-cigarette FMCG business grew by 11.4% during the quarter.

  • Hotels posted a muted growth of 4.7% during the quarter due to weak environment coupled with gestational costs on new properties and additional depreciation charges from revision in useful life of fixed assets as per Companies Act. The agri business was adversely impacted by lack of trading opportunities in soya and witnessed the steepest decline of 10.6% during the quarter. Even the paper business saw erosion in revenues due to slowdown in the FMCG and cigarette businesses.

    All round picture
      % contribution to sales Revenue growth PBIT growth PBIT margin (%) PBIT margin gain/(decline) in basis points
    Cigarettes 43% 0.6% 8.8% 69.7% 524
    Others 24% 11.4% 10.7% 0.5% 0
    Total FMCG 67% 4.2% 8.8% 44.9% 189
    Hotels 3% 4.7% -53.8% 8.7% -1103
    Agri Business 17% -10.6% 16.3% 14.9% 345
    Paperboards, Paper & Packaging 13% -4.7% -7.7% 17.0% -232

  • Backed by lower cost of goods sold and other expenses (both as a proportion of sales), operating margin expanded by 1.1% during the quarter. Among business segments, cigarettes saw the sharpest expansion in EBIT margin during the quarter indicating price hikes taken to pass on the duty hike. EBIT margin for the non-cigarette FMCG business remained flat whereas agri business expanded EBIT margin by 3.4% during the quarter driven by improved realizations. However, both hotels and paper segments eroded their profitability during the quarter.

  • Net profits grew by a faster 10.5% backed by a 48.8% jump in the other income earned. The tax incidence remained at 31% whereas interest expenses fell by 8.4% during the quarter.
What to expect?

Excise duty hikes for three consecutive years are beginning to impact ITC's cigarette business. The company enjoys pricing power in cigarettes and has been able to pass on the excise-hikes in the past. However, in December 2014 quarter while price increase enabled the company to improve margins but its offtake has fallen sharply resulting in flat growth in cigarette sales. As per Tobacco Institute of India, higher tax rates led to a double-digit decline in the sale of legal cigarettes in the second half of 2014. Going ahead, the government wants to maintain a tough stance against cigarette smoking with proposals such as ban on sale of loose cigarettes and raising the age limit of cigarette smokers being under consideration. With cigarette business already under pressure, ITC's other large business of FMCG continues to face slowdown in discretionary spending and high competition. As cigarettes still make up more than 40% of the company's turnover, the punitive measures will adversely impact the company's sales and profitability in the near future.

At the current price of Rs 360, the stock trades at a P/E multiple of 23 times its estimated FY17 earnings. With FY17 target price of Rs 391, the compounded annual return works out to 3.8% over the next 2-3 years. This along with a dividend yield of 1.7% translates to an overall return of 5.5%. As the current high valuations do not provide an adequate margin of safety that we seek in all our recommendations, we would recommend that subscribers do not buy the stock at current levels.

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