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ITC: Steady growth

Jul 27, 2007

Performance summary
  • Topline for 1QFY08 is up 17% YoY driven by the non-cigarette business, which grew by 18% YoY.

  • While cigarette division grew by 9% YoY, branded foods division reported 66% YoY growth.

  • The margins for the quarter remained stable at 34% as the overhead costs (as a percent of sales) remained stable.

  • The company has recorded a 20% YoY growth in net profits.

Rs(m) 1QFY07 1QFY08 (%) Change
Net sales 28,498 33,252 16.7%
Expenditure 18,792 21,977 16.9%
Operating profit (EBDITA) 9,706 11,276 16.2%
EBDITA margin (%) 34.1% 33.9%  
Other income 849 1016 19.6%
Interest 7 -8 -215.3%
Depreciation 876 1010 15.3%
Profit before tax 9,672 11,289 16.7%
Tax 3,149 3,461 9.9%
Profit after tax/(loss) 6,523 7,829 20.0%
Net profit margin (%) 22.9% 23.5%  
No. of shares (m) 3,755 3,762  
Diluted earnings per share (Rs)*   7.5  
Price to earnings ratio (x)   23.1  

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 1QFY08?
ITC posted a strong topline growth of 16.7% YoY in 1QFY08 driven by the non-cigarette business, which grew by 18% YoY. The key growth drivers for this quarter were the food, agri and the hotel divisions. Lets look at the segment performance.

Revenue Mix
(Rs m) 1QFY07 1QFY08 Change
Cigarettes 31,592 34,415 8.9%
% of revenues 59.3% 56.0%  
Others 3,597 5,422 50.8%
  6.7% 8.8%  
Total FMCG 35,189 39,837 13.2%
  66.0% 64.8%  
Hotels 1,988 2,212 11.3%
  3.7% 3.6%  
Paperboards, paper & packaging 5,015 5,262 4.9%
  9.4% 8.6%  
Agri business 11,111 14,181 27.6%
  20.8% 23.1%  
Total turnover 53,302 61,492 15.4%
Less: Inter segment revenues 6,961 9,711 39.5%
Gross sales 46,341 51,781 11.7%

Cigarette division: The main division of ITC grew by 9% YoY in the quarter under consideration. However, its share to the total revenues has fallen to 56% from 59% in 1QFY07. During the quarter, VAT on cigarettes at the rate of 12.5% became effective in most states. In the State of UP, a trade tax of 33.5% (inclusive of Development Cess) was levied on cigarettes. These imports were in addition to the increase in excise duties on cigarettes in excess of 6% in the Union Budget 2007. Hence the severe taxation and regulatory milieu for cigarettes in India remained a cause of concern. However, the company had taken 20% price hikes across its brands to offset the VAT costs. Though the management expects this year to perform marginally lower, it expects the growth to pick up in the next year.

Hotels: Driven by strong industry scenario and increased room rates, the hotel business grew by 11% YoY. ITC plans to add three new properties over the next three to four years (one each in Bangalore, Hyderabad and Chennai). It is adding around 900 new rooms, which are expected to come in by FY09. The company is planning an investment of around Rs 10 bn for the next three years to capitalise on the robust scenario.

Paperboards, Specialty Paper & Packaging: The performance of this division was sedate with revenues growing by 5% YoY. This was on account of the planned shutdown of a paperboard machine at Bhadrachalam for its upgradation. Consequently, its share in the total revenues fell from 9% in 1QFY07 to 8.6% in this quarter. However, the division is expected to witness decent growth going forward once the machine stabilizes. Steady progress is being made in completion of the capacity augmentation projects (a new paper machine and an additional pulp mill) at Bhadrachalam. The paperboard project will augment capacity by 90,000 tonnes per annum (TPA) in FY09. The company is planning total investment of Rs 10 bn for the next 3 years for the division.

Agri business: Agribusiness revenues grew by a robust 27% YoY, driven primarily by increased exports of leaf tobacco, higher soya trade and enhanced wheat sales to the company's branded packaged foods business. The share of the division to the total revenues has gone up by 230 basis points. The company has continued with expanding its choupal networks. 3 more 'Choupal Saagars' were launched during the quarter. Eighteen 'Choupal Saagars' are now operational in the 3 states of Madhya Pradesh, Maharashtra and Uttar Pradesh, while 8 more are in an advanced stage of construction. This e-choupal network would serve as the core infrastructure to support ITC's rural distribution strategy. The network is already contributing in a great way to procure the raw materials for its branded packaged food business, which the management expects to be the next growth driver. This would help the company reduce its costs.

Branded Packaged Foods business: The segment grew by a strong 66% YoY over last year. In March 2007, the company had launched Bingo range of potato chips and finger snack foods. In next two years, ITC would be investing Rs 1.5 bn on ‘Bingo’. Its 'Sunfeast' range of biscuits also continued with its good performance with improvement in the product mix and higher sales of value added products like creams and cookies. The confectionary category recorded robust sales with growth of 58% YoY led by new variants in hard boiled category and launch on new products like 'Mint-O Fresh Cool Green' and 'Candyman Mango Licks'. ITC continues to also build its leadership in the atta segment. It further enhanced its spread with entry into the branded spice business. Currently, the size of the snack food market is estimated to be Rs 45 bn of which branded players account for Rs 20 bn. The snack food market is growing at 30% annually. ITC is planning to capture 25 % market share in the branded segment and is making necessary investments.

Others: Lifestyle Retailing business recorded an impressive growth of 31%Yoy during the quarter. In the popular segment, the 'John Players' brand posted notable gains with sales growing by 40% YoY. The company also launched a new brand “Miss players” for women. It also added four new stores and is also pursuing opportunities in the exports arena. The safety matches & incense sticks business also continued its strong performance. Acquisition of WIMCO Ltd. by Russell Credit Ltd., (a wholly owned subsidiary of the Company) has ensured that the business continues to enjoy product leadership. The stationery business continued to perform impressively with growth rate of 62% YoY over last year.

The company is also planning to enter into home and personal care segment. It is planning to enter the markets with premium perfumes and later extend it to other personal care products. With rising income and changing lifestyles, the segment is witnessing strong growth.

Cost break-up
Cost break-up
As a % of net sales 1QFY07 1QFY08
Total Cost of goods 43.2% 43.1%
Staff Cost 5.4% 5.3%
Other Expenditure 17.4% 17.6%

Stable margins: The margins for the quarter remained stable at 34%. All the overhead costs (as a percent of sales) remained stable. Cigarette margins improved 1.5%YoY. The company had taken a price hike of around 20% to cover the VAT loses. FMCG-Others’ profitability improved significantly by 800 basis points YoY on the back of improved scale. The margins of the hotel segment remained stable, while that of the paper division witnessed a decline of 3% YoY due to lower production. The margins of agri business witnessed marginal fall due to investments in the e-choupal network.

PBIT margin trend…
(% of segmental revenues) 1QFY07 1QFY08
Cigarettes 25.8% 27.3%
Others -16.2% -8.2%
Total FMCG 21.5% 22.5%
Hotels 29.0% 29.0%
Paperboards, paper & packaging 20.9% 16.5%
Agri business 4.2% 3.8%
Total PBIT 18.1% 17.9%

On the bottomline: Stable margins aided by lower interest and tax costs have led to the company reporting a 20% YoY growth in net profits. The margins are higher by 70 basis points.

What to expect?
At the current price of Rs 174, the stock is trading at a price to earnings multiple of 16.9 times our FY10 estimates. ITC has been aggressively investing in new businesses and ventures in the past few years. It has planned an investment of Rs 35 bn over the next three years, allocated across different divisions. Although, it has been successful in reducing its revenue dependence on cigarettes business, profit mix is still largely dependent on it. However, once the other segments start witnessing higher growth, this would turn favorable. Given its unmatched distribution strengths and strong execution capabilities, we remain positive on the stock from a long-term perspective.

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