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ITC: Non-tobacco story panning out - Views on News from Equitymaster
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ITC: Non-tobacco story panning out
Jul 29, 2005

Introduction to results
Tobacco major, ITC, reported yet another good set of numbers for the June quarter with a near 25% YoY topline (net sales) growth. However, higher raw material costs put pressure on margins leading to a slower growth in bottomline. It must be noted that the company has embarked on a conscious move to de-risk its revenue model by increasing the share of its other businesses in its total revenue pie, glimpses of which were visible in this quarter.

(Rs m) 1QFY05 1QFY06 Change
Gross Sales 33,399 39,606 18.6%
Net Sales 18,172 22,669 24.7%
Expenditure 11,080 14,401 30.0%
Operating Profit (EBDIT) 7,092 8,268 16.6%
Operating Profit Margin (%) 39.0% 36.5%  
Other Income 581 845 45.5%
Interest (net) 129 11 -91.6%
Depreciation 728 801 10.0%
Profit before Tax 6,816 8,301 21.8%
Tax 2,167 2,718 25.5%
Profit after Tax/(Loss) 4,649 5,583 20.1%
Net profit margin (%) 25.6% 24.6%  
No. of Shares (m) 248.9 249.4  
Diluted Earnings per share (Rs)* 74.7 89.5  
P/E Ratio (x)   18.8  
*(annualised)      

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 ITC 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. ITC, through its wholly owned investment subsidiary, Russell Credit Limited, recently acquired Wimco Limited from a Swedish company. Wimco dominates the highly fragmented Rs 13 bn matchstick market and has a 13% share.

What has driven performance in 1QFY06?
Cigarettes:  Despite operating in a challenging environment, with severe restrictions on advertisement, ITC reported a decent 12% YoY growth (value terms) during the quarter in this segment. Further, excise duty rates were increased by 10% for cigarettes in March 2005 forcing the major to increase prices of some of its brands. Cigarette continues to be the mainstay of the company and contributes to around 85% of the company’s PBIT.

Revenue mix
  1QFY05 1QFY06
Cigarettes 77.3% 73.3%
Others 3.2% 5.2%
Total FMCG 80.5% 78.5%
Hotels 3.3% 3.8%
Paperboards, paper & packaging 11.5% 11.9%
Agri business 14.0% 19.5%
Total turnover 109.3% 113.6%
Less: Inter segment revenues 9.3% 13.6%
Gross sales 100.0% 100.0%

Branded packaged foods:  ITC’s foods business continued to display fast growth (over 90% YoY) albeit on a small base. This growth could be attributed to the launch of a couple of products under the Sunfeast brand both of which received overwhelming response from consumers. Further, in the June quarter, ITC forayed into the branded spices market under the ‘Aashirvaad’ label. While this business continues to eat into the company’s profits, it must be noted that as compared to a PBIT of –37% in 1QFY05, it has come down to –27% for the current quarter.

Hotels:  This division continues to be the fastest growing segment for the company. During the June quarter, this division saw a growth of 35% YoY and margins stood at over 38% (see table below), overtaking all other businesses. It must be noted that during the quarter under review, an extraordinary one-time income to the tune of Rs 267 m (included in other income) was incurred due to the settlement with Sea Rock hotel in Mumbai. PBIT from this segment grew at a whopping 343% YoY, due to increased room realisations and high occupancy rates across its properties.

Paperboards:  ITC’s paperboard unit at Bhadrachalam is the largest and most contemporary paperboards manufacturing facility in the country and accounts for over 80% of the company’s total installed paperboard capacity of 325,000 tonnes. However, margins for this business saw a dip of 230 basis points.

Segment PBIT margins
(Rs m) 1QFY04 1QFY05
Cigarettes 23.1% 24.4%
Others -37.1% -27.3%
Total FMCG 20.7% 21.0%
Hotels 11.7% 38.2%
Paperboards, paper & packaging 21.7% 19.4%
Agri business 5.6% 4.8%
Total PBIT 18.6% 18.7%

Margins contract:  The operating margins during the quarter was lower by 250 basis YoY, which could be attributed largely to higher material costs. As can be seen in the table below, material costs as a percentage of net sales increase from about 35% in 1QFY05 to 39% in 1QFY06. The other two operating heads remained largely under control.

Cost break-up
as % of sales 1QFY05 1QFY06
Material cost 35.1% 38.6%
Staff cost 6.0% 5.5%
Other exp. 19.8% 19.5%
Total expenses 61.0% 63.5%
Other income prop:  Higher capital expenditure in hotels and paperboards businesses has led to higher depreciation provisioning for the quarter. However, one must note that interest costs have gown down considerably in the quarter, which has supported the bottomline well. Further, a strong growth in other income also helped matters. However, if we remove the one time income of the hotels division, bottomline has grown by only 14% YoY. Nonetheless, this growth too would have not been too disappointing.

Over the past few quarter…
  1QFY05 2QFY05 3QFY05 4QFY05 1QFY06
Net sales growth (YoY) 24.2% 13.1% 10.6% 15.7% 24.7%
Cigarette value growth (YoY) 10.8% 11.2% 5.1% 6.4% 18.7%
Excise as % of gross sales 45.6% 47.2% 44.6% 39.4% 42.8%
OPM (%) 39.0% 40.2% 37.6% 30.5% 36.5%
Net profit growth (YoY) 16.3% 13.5% 17.9% 99.3% 20.1%

As can be seen from the table above, the profit levels are the highest in the past few quarters. In 4QFY05, there was an extraordinary income, due to which the profits had inflated. One must note that despite cigarettes growing at a decent pace, its contribution to overall revenues has decreased which is a positive for the company in the long run, given the fact that it is a highly regulated industry being dependent on government policies and operates in a very challenging environment.

What to expect?
At the current price of Rs 1,685, ITC is trading at a price to earnings multiple of 18.8 times its 1QFY06 annualised earnings and market cap to gross sales of 2.7x. The merger of ITC Hotels has not only increased non-tobacco revenues, but also resulted in cost savings through better synergies. Overall, we are enthused by ITC's performance and believe that the company's non-tobacco initiatives are on track. The company remains one of our preferred plays in the FMCG sector from a two to three year perspective.

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