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ITC: Across-the-board growth! - Views on News from Equitymaster
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ITC: Across-the-board growth!
Jan 31, 2007

Performance summary
Tobacco major, ITC, reported a robust performance for the December quarter, with a near 24% YoY growth in net sales. The margins for the quarter remained steady at 34%. Barring the one-time extraordinary effect in 3QFY06, bottomline has grown in line with the topline. The company’s effort to de-risk its revenue model by increasing the share of its other businesses in its total revenue pie is yet again visible in this quarter.

Rs(m) 3QFY06 3QFY07 (%) Change 9mFY06 9mFY07 (%) Change
Net sales 25,560 31,656 23.8% 70,061 89,030 27.1%
Expenditure 16,777 20,828 24.1% 44,811 58,769 31.1%
Operating profit (EBDITA) 8,783 10,828 23.3% 25,249 30,261 19.8%
EBDITA margin (%) 34.4% 34.2%   36.0% 34.0%  
Other income 489 698 42.8% 2115 2342 10.8%
Interest 15 -9   23 33 46.1%
Depreciation 831 921 10.8% 2462 2707 10.0%
Profit before tax 8,426 10,614 26.0% 24,880 29,863 20.0%
Extraordinary item (454) -   (454) -  
Tax 2,603 3,440 32.1% 7,751 9,370 20.9%
Profit after tax/(loss) 5,368 7,174 33.6% 16,675 20,493 22.9%
Net profit margin (%) 21.0% 22.7%   23.8% 23.0%  
No. of shares (m) 3,760 3,760   3,760 3,760  
Diluted earnings per share (Rs)*         7.0  
Price to earnings ratio (x)         25.3  
* 12 months trailing earnings            

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 the company 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 3QFY07?
All round growth: ITC recorded 23.8% YoY growth during 3QFY07 buoyed by robust growth in all businesses. ITC has been slowly and gradually lowering its dependence on cigarette (high margin) business and increasing its focus on the other businesses.

(%of gross sales) 3QFY06 3QFY07 9mFY06 9mFY07
Cigarettes 63.9% 61.6% 65.1% 60.5%
Others 5.8% 8.2% 5.5% 7.7%
Total FMCG 69.7% 69.8% 70.6% 68.2%
Hotels 4.9% 5.3% 4.0% 4.3%
Paperboards, paper & packaging 10.9% 10.2% 11.0% 9.9%
Agri business 14.5% 14.7% 14.5% 17.5%
Total turnover 100.0% 100.0% 100.0% 100.0%
Less: intersegment revenues 7.0% 6.5% 9.0% 9.7%
Gross sales 93.0% 93.5% 91.0% 90.3%

Cigarettes: Despite operating in a challenging environment due to severe restrictions on advertisement and communication, cigarettes in 3QFY07, reported a 14% YoY growth. Though the share of cigarettes to the total turnover has gone down from 64% in 3QFY06 to 62% in 3QFY07, it continues to be the mainstay of the company and contributes around 81% of the company’s PBIT. However recent reports suggest that policy makers are considering the possibility of States extending VAT to cigarettes, to compensate for the loss in CST revenues and this may affect the volumes of the company going forward.

Foods business: The Branded Packaged Foods business continued to expand rapidly, with sales for the quarter growing by 65% YoY. New product launches and enhanced sales of value added products improved the product mix in the quarter. The ‘Sunfeast’ brand continued its strong performance with newer launches in the mid market segment and further brand extensions. In the Staples category, ‘Aashirvaad Atta’ grew from strength to strength and now commands an impressive 55% market share amongst national branded players. Confectionery sales also recorded strong growth driven by ‘Eclairs’ and ‘Cofitino’ in the toffee segment and the national roll out of ‘Mango Natkhat’ (a hard-boiled candy).

Hotels: Like its peers, ITC too benefited from the strong tourist inflow into the country during 2006. This division recorded a growth of 29% YoY for the quarter backed by 37% YoY growth in its RevPAR (revenue per available room). Higher room realisations and higher occupancy rates across its properties have helped the division increase its contribution to the total sales by 40 basis points. The company’s expansion plans are also on track and will help the company to take advantage of the favourable demand supply gap prevailing in the country.

Paperboards, paper and packaging: Sales of value added paperboards continued to record strong growth during the quarter, further enriching the product mix. These products now constitute about 55% of total paperboard sales which grew by 11% YoY for 3QFY07. The company has lined up major expansion plans in this segment and is planning to add about 90,000 TPA by 2008. An investment towards setting up capacity for manufacturing about 100,000 TPA of uncoated paper (including branded copier grades) to tap the emerging growth opportunities and further consolidate its market standing is planned, which is also expected to come on stream by 2008. The company’s plantation programme was further scaled up during the quarter. With regards the packaging and printing business, the new facility in Uttaranchal, which would add manufacturing capacity both in the paperboard cartons and flexibles segments, is expected to be commissioned shortly. The facility would enable the business to increase its sales going forward.

Agri business: Led by the exports of leaf tobacco and increased levels of trade in soya, non-basmati rice, chana and coffee, agribusiness revenues recorded a growth of 20% YoY. Cigarette leaf tobacco exports also recorded robust growth during the quarter on the back of new business development initiatives and the strategy of offering customised product and service offerings to key customers. On the rural retail front, 12 ‘Choupal Saagars’ are now operational in the 3 states of Madhya Pradesh, Maharashtra and Uttar Pradesh, while 8 more are expected to be launched by April 2007. These ‘Choupal Saagars’, in synergistic combination with the e-Choupal network, would serve as the core infrastructure to support ITC’s rural distribution strategy. The contribution to the total revenues has remained stable at 14%.

Other divisions: While lifestyle retailing, greeting cards segment and safety matches are small contributors to the revenues, these divisions have performed well in the quarter. The Lifestyle Retailing business grew by an impressive 38% YoY during the quarter led by strong sales growth across its portfolio due to higher average realisations, footfalls/conversion and sell through rates. The ‘Wills Lifestyle’ range is currently available in 39 large format retail stores and 156 multi-brand outlets apart from the 39 exclusive ‘Wills Lifestyle Stores’. The company will launch 15 new stores in upcoming malls to enhance its retail footprint over the next few months to increase its market presence. The stationery business witnessed an increase of 27% YoY in sales during the quarter. In the safety matches business, the company’s brands continued to enjoy strong consumer preference, resulting in enhanced market standing.

Cost break-up
As a % of net sales 3QFY06 3QFY07 9mFY06 9mFY07
Total Cost of goods 40.7% 42.6% 38.9% 42.8%
Staff Cost 5.3% 5.2% 5.7% 5.2%
Other Expenditure 19.6% 18.0% 19.4% 18.0%

Steady margins: Operating margins remained stable at 34% in 3QFY07. Though raw material cost as percentage of sales has increased, lower staff and other costs enabled ITC to maintain its margins. Cigarettes division margins stood at 25% for the quarter up from 24% in 3QFY06, led by better realisations. Though the foods business continues to eat into the company’s profits, it must be noted that as compared to a PBIT of -15% in 3QFY06, it has come down to -11% in the current quarter. The hotel division’s PBIT grew by 55% YoY and contributed 12% to the total PBIT. The paperboards PBIT as percentage of segmental revenues improved from 18.7% in 3QFY06 to 19.2% in the current quarter and grew by 14% YoY. The PBIT of the agri business recorded a strong growth of 45% YoY.

PBIT margin trend…
(% of segmental revenues) 3QFY06 3QFY07 9mFY06 9mFY07
Cigarettes 24.1% 25.3% 24.5% 25.5%
Others -15.1% -10.6% -18.3% -12.7%
Total FMCG 20.8% 21.0% 21.2% 21.2%
Hotels 35.0% 42.0% 30.8% 34.3%
Paperboards, paper & packaging 18.7% 19.2% 19.2% 20.4%
Agri business 2.3% 2.8% 4.4% 4.2%
Total PBIT 18.6% 19.3% 18.9% 18.7%

Net profit view: The bottomline growth at 33.6% YoY was higher than the topline due to the rise in other income and the impact of the extraordinary item in 3QFY06, which was no there this quarter. Barring this extraordinary effect in 3QFY06, bottomline has grown by 23.2% YoY, which is line with the topline growth.

What to expect?
At the current price of Rs 175, the stock is trading at a price to earnings multiple of 25.3 times its 12-months trailing earnings. The strong growth in the cigarette business indicates continuing strong volume growth. However the government stand on VAT may affect the volumes going forward. The outlook on the non-cigarette businesses such as hotels and paper is likely to remain positive with continued buoyant demand. The other FMCG businesses are also rapidly expanding, while losses are being gradually curtailed. Given the positive outlook for the Indian tourism industry due to increasing foreign tourists, we expect ITC to grow its hotels segment going forward. Also, the agri, food and retailing segments are expected to perform well in the future. However, despite visible growth prospects, medium term valuations look stretched.

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