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ITC: Cigarettes, and more - Views on News from Equitymaster
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ITC: Cigarettes, and more
Jul 21, 2006

Performance summary
Diversified major, ITC reported yet another good set of numbers for the June quarter with a near 26% YoY growth in topline. The company’s conscious move to de-risk its revenue model by increasing the share of non-tobacco businesses in its total revenue pie was visible again in this quarter. The bottomline grew by 17% YoY. However, higher raw material costs took toll of the operating margins, which contracted by 2.4% during 1QFY07.

Consolidated view
Rs(m) 1QFY06 1QFY07 (%) Change
Net sales 22,669 28,498 25.7%
Expenditure 14,401 18,792 30.5%
Operating profit (EBDITA) 8,268 9,706 17.4%
EBDITA margin (%) 36.5% 34.1%  
Other income 845 849 0.5%
Interest 11 7 -33.3%
Depreciation 801 876 9.5%
Profit before tax 8,301 9,672 16.5%
Extraordinary income 195 -  
Tax 2,718 3,149 15.8%
Profit after tax/(loss) 5,583 6,523 16.8%
Net profit margin (%) 24.6% 22.9%  
No. of shares (m) 2494.0 3755.0  
Diluted earnings per share (Rs)*   6.2  
Price to earnings ratio* (x)   27.1  
* 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 1QFY07?
All round growth: ITC's cigarette business grew at a commendable rate of 11% YoY during 1QFY07. Along with this, the growth in other key business divisions i.e., hotels, agri-exports and other FMCG segments, is a vindication of the company’s scalability. The hotel division’s revenue grew by 35% YoY due to the buoyancy in tourism in the country. Higher room rates and occupancy rates have thus helped the surge in revenues for the segment. The agri-business showed a robust growth of 47% YoY during the quarter, thereby increasing its contribution to the overall topline to 21% (17% in 1QFY06). Paper products and other division (snacks, branded garments and ready to eat foods) grew by 9% YoY and 80% YoY respectively

Input costs weight heavy: Higher raw material costs have dented margins during the quarter (see table below), which reduced from 36.5% in 1QFY06 to 34.1% 1QFY07. The contraction would have been higher but for the decline in direct costs and staff expenses. While cigarette margins have improved, hotels paperboards and agri segments have shown decline in the margins.

Cost break-up
As a % of net sales 1QFY06 1QFY07
Total Cost of goods 38.6% 43.2%
Staff Cost 5.5% 5.4%
Other Expenditure 19.5% 17.4%

It boils to the bottomline: The effect of contraction in operating margins is visible in the bottomline, where growth has underperformed the topline growth.

PBIT margin trend…
(% of segmental revenues) 1QFY06 1QFY07
Cigarettes 24.4% 25.8%
Others -27.3% -16.2%
Total FMCG 21.0% 21.5%
Hotels 38.2% 29.1%
Paperboards, paper & packaging 19.4% 20.0%
Agri business 4.8% 4.2%
Total PBIT 18.7% 18.1%

What to expect?
At the current price of Rs 168, the stock is trading at a price to earnings multiple of 27.1 times its 12-months trailing earnings. We are buoyed by the company’s performance in the first quarter and believe that it shall be able to carry on the same in the future as well. Though medium-term valuations look stretched, investors with long-term horizon can have ITC as part of their portfolio.

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