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ITC: Catch-22 situation

May 29, 2001

ITC is set to declare FY01 results tomorrow. The results gain importance as the company’s prospects have come under a cloud following reports of falling volumes in its cash cow cigarette business. We take a look. ITC (FY00 turnover Rs 79 bn) operates in five principal businesses - tobacco and cigarettes, hotels, paper and packaging and international trading. It is the industry leader in its core business of cigarette manufacturing and tobacco (67% market share) processing in India. It is also one of India's largest foreign exchange earners (Rs 6.9 bn in FY00). ITC has consolidated its position in the cigarette industry even in adversity. However, punitive taxes and smuggled foreign cigarette brands have slowed volume growth for this company. Thus, apart from concentrating on its core business of cigarettes ITC has continuously increased its exposure to new businesses like hotels, IT and sportswear retailing. ITC has a presence in the paper/packaging segment through ITC-Bhadrachalam Paperboards and now owns over 70% in ITC Hotels.

(Rs m) 3QFY00 3QFY01 Change 9m FY00 9m FY01 Change
Gross Income 19,918 21,617 8.5% 59,189 64,670 9.3%
Net Sales Turnover 9,608 11,068 15.2% 27,936 31,157 11.5%
Other Income 218 292 33.9% 752 855 13.8%
Expenditure 6,412 7,171 11.8% 17,735 18,594 4.8%
Operating Profit (EBDIT) 3,196 3,897 21.9% 10,200 12,563 23.2%
Operating Profit Margin (%) 33.3% 35.2%   36.5% 40.3%  
Interest 266 251 -5.6% 908 723 -20.4%
Depreciation 314 365 16.2% 875 1,034 18.1%
Profit before Tax 2,834 3,573 26.1% 9,168 11,661 27.2%
Tax 1,162 1,412 21.5% 3,493 4,562 30.6%
Profit after Tax/(Loss) 1,672 2,161 29.3% 5,675 7,100 25.1%
Net profit margin (%) 17.4% 19.5%   20.3% 22.8%  
No. of Shares (eoy) (m) 245.4 245.4   245.4 245.4  
Earnings per share* 27.3 35.2   30.8 38.6  
*(annualised)            
Current P/e ratio         20.2  

For the nine-month period ending December 2000, ITC logged in a 25% growth in net profits. This jump was on the back of an 11% growth in net turnover during the same period. The company’s operating profit margins also went up from 36.5% in 9m FY00 to 40.3% in 9m FY01. Please note that ITC pays more than 50% of its gross turnover as excise duty. ITC’s FY01 results are expected to be in line with its nine month performance. It might be even a shade better considering cost cuts as a result of the ban on tobacco advertising in sports and cultural events.

However, there are reports that the company’s cigarette dispatches have dipped by 13% in April 2001. The company has neither confirmed nor denied this till now. But a decline in volumes was expected considering that ITC had hiked cigarette prices in November 2000 and was forced to increase prices again post the excise hike in the budget 2002. While cigarette demand is considered largely price inelastic, the continuous hike in prices seems to have met with resistance from the consumers. Alternatively, these continuous price hikes seem to have made imported cigarettes more competitively placed. So some consumers may have switched to the imported brands.

In the current scenario ITC is in a fix. On the one hand, the government’s continuous hike in excise duty has forced ITC to pass on the hike to the consumer on a regular basis. This has resulted in pressure on volume growth. On the other hand, its investments in hotels and sports retailing are at a nascent stage and will take some time to significantly contribute to the bottomline. One must also remember that in 2002 all companies will have to declare consolidated results and it is only during that time a true picture of ITC’s financial health will emerge. Historically, ITC’s other businesses have always been a drain on its resources.

At the current price of Rs 778 the stock trades at a P/E multiple of 20.2 x its FY01E. The stock has been stuck around this valuation for quite some time given the uncertainty over its future growth especially in its non-cigarette businesses. Historically, ITC has always managed to hold onto its market share in cigarettes even in adverse conditions and if it manages to do so this time around also, only then will the company see better valuations.


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