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ITC 2QFY08: Our view

Oct 26, 2007

Performance summary
  • Topline for 2QFY08 witnesses a growth of 14.2% YoY led by double digit growth in its FMCG, hotels and paperboard segments.
  • The margins for the quarter fall by 2.4% YoY as the raw material costs (as percentage of sales) increase.

  • The company records a 13% YoY growth in net profits.

  • For 1HFY08, topline and bottomline increases by 15% YoY and 17% YoY respectively.

Rs(m) 2QFY07 2QFY08 (%) Change 1HFY07 1HFY08 (%) Change
Net sales 28,659 32,734 14.2% 56,854 65,672 15.5%
Expenditure 18,932 22,414 18.4% 37,423 44,077 17.8%
Operating profit (EBDITA) 9,727 10,320 6.1% 19,432 21,595 11.1%
EBDITA margin (%) 33.9% 31.5%   34.2% 32.9%  
Other income 795 2083 162.0% 1644 3098 88.5%
Interest 35 9 -73.9% 42 1 -98.1%
Depreciation 910 1062 16.7% 1786 2072 16.0%
Profit before tax 9,577 11,331 18.3% 19,248 22,620 17.5%
Tax 2,782 3,623 30.2% 5,930 7,083 19.4%
Profit after tax/(loss) 6,795 7,709 13.4% 13,318 15,537 16.7%
Net profit margin (%) 23.7% 23.5%   23.4% 23.7%  
No. of shares (m) 3,757 3,764   3,757 3,764  
Diluted earnings per share (Rs)*         7.8  
Price to earnings ratio (x)         23.2  
* 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 2QFY08?
Revenue scenario: ITC posted a strong topline growth of 14.2% YoY in 2QFY08. While its cigarette business grew by 11.6% YoY, non-cigarette segments grew by 16.7% in 2QFY08.

Revenue mix
(Rs m) 2QFY07 2QFY08 (%) Change 1HFY07 1HFY08 (%) Change
Cigarettes 14,097 15,737 11.6% 28,296 32,114 13.5%
% of revenues 42.4% 42.9%   41.5% 40.6%  
Others 4,096 5,870 43.3% 7,693 11,292 46.8%
  12.3% 16.0%   11.3% 14.3%  
Total FMCG 18,193 21,607 18.8% 35,989 43,407 20.6%
  54.7% 58.9%   52.7% 54.8%  
Hotels 1,839 2,081 13.2% 3,660 4,119 12.5%
  5.5% 5.7%   5.4% 5.2%  
Paperboards, paper & packaging 4,757 5,596 17.6% 9,318 10,383 11.4%
  14.3% 15.3%   13.7% 13.1%  
Agri business 8,470 7,407 -12.5% 19,279 21,274 10.3%
  25.5% 20.2%   28.2% 26.9%  
Total turnover (net) 33,258 36,691 10.3% 68,246 79,183 16.0%
Less: Inter segment revenues 4,600 3,957 -14.0% 11,392 13,511 18.6%
Net sales 28,659 32,734 14.2% 56,854 65,672 15.5%

Cigarettes - Taxing times: The company’s main division (cigarette) grew by 12% YoY for 2QFY08. During 1HFY08, VAT, central sales tax and trade tax in UP was imposed on cigarettes and smoking mixtures. An increase of 29% YoY per pack in taxes was witnessed, thereby leading to lower volumes. Rates of taxation amount to nearly 132% of the value of the product. The company was subject to additional taxation amounting to Rs 4 bn and Rs 8 bn for 2QFY08 and 1HFY08 respectively. The division contributed nearly 43% to the net revenues.

Others: The FMCG others’ revenues grew by 43% YoY with its contribution to net revenues touching 16%. The Branded Packaged Foods business continued to expand rapidly with sales growing 58% YoY. Biscuits grew by 54% YoY, while atta products reported a strong growth of 44% YoY. The company launched its new range of "Aashirvaad Select Organic Spices". It recently signed an MOU with the Government of Nagaland and the Spices Board for the development of the famed Naga chilli through a host of initiatives across the agri-value chain. The confectionary category grew by 33 % YoY aided by éclairs and new launches.

ITC acquired the entire shareholding in Technico Pty. Ltd., through Russell Credit Limited, a wholly owned subsidiary of the Company (Russell Credit). The acquisition is expected to provide strategic sourcing support to ITC's salty snacks business.

The lifestyle segment reported a growth of 21% YoY led by store expansions, higher volumes and realisations. While the stationery division grew by 55% YoY, the Safety Matches & Incense Sticks segment grew by 14% YoY. The company also ventured into the personal care segment in the quarter with the launch of 'Essenza Di Wills', an exclusive range of fine fragrances and 'Fiama Di Wills', a premium range of shampoos and shower gels. It also launched the 'Superia' range of soaps and shampoos in the mass-market segment in select markets of Andhra Pradesh and Orissa.

Hotel division- Revpar driven: Hotels contributed 5.7% to the net revenues, with a growth of 13.2% YoY in the revenues, led by improved revenues per available room (RevPar). The construction of new luxury hotels at Bangalore and Chennai is progressing well. During the quarter, the company also acquired land at Hyderabad to build a premium property in the near future.

Paper - On expansion: The paperboard division reported a 17.6% YoY jump in revenues during the quarter. This was driven by stabilisation of the paperboard machine at Bhadrachalam after it was rebuilt and growth in sales of value added paperboard. The company’s expansion plans are on track and will augment capacity by about 100,000 TPA in 2008/09. Further, the pulp mill with a capacity of 120,000 tonnes of hardwood pulp is to be commissioned in the last quarter of this fiscal, which would provide a distinct cost advantage, apart from removing the dependency on imported hardwood pulp.

Agri - Effect of bans: The agri division, however, under performed with a sales decline of 13% YoY. The performance was adversely impacted as the company had to dispose off agri commodities in the domestic market at prices lower than those paid to farmers through the eChoupal network. This was due to ban on exports of certain commodities and nil import duties, which along with subsidised auction sales, depressed prices in the domestic market. Further, the sharp appreciation of the rupee affected realisations on exports. However, the management is positive on the segment going forward.

Further 19 Choupal Saagars are now operational in the states of Madhya Pradesh, Maharashtra and UP. The horticulture products retail shops were extended during the quarter with the launch of four stores and nine shop-in-shops (through tie-ups with Food Bazaar and TruMart) in the cities of Hyderabad and Pune. Though the half yearly sales are lower than our estimates, we are positive on its performance going forward.

Cost break-up
As a % of net sales 2QFY07 2QFY08 1HFY07 1HFY08
Total Cost of goods 42.2% 44.5% 42.4% 43.5%
Staff Cost 5.2% 5.3% 5.3% 5.4%
Other Expenditure 18.6% 18.6% 18.1% 18.2%

Cost pressure: The margins in 2QFY08 fell to 31.5% from 33.9% in 2QFY07. While other costs (percentage of sales) have remained stable, raw material costs increased from 42.2% in 2QFY07 to 44.5% in the current quarter leading to the dent in the margins. The PBIT margins of cigarette division reduced by 0.9% due to additional taxation in UP. However, its contribution to total PBIT increased from 82.6% in 2QFY07 to 84% in the current quarter. The FMCG others segment, though in losses, is showing improvement. PBIT margins of hotel and paper segment showed marginal improvement for the quarter. The PBIT profits for agri business were down 78% YoY. The margins fell from 5.4% to 1.3% in the quarter.

PBIT margin trend…
(% of segmental revenues) 2QFY07 2QFY08 1HFY07 1HFY08
Cigarettes 55.8% 54.9% 56.6% 56.1%
Others -12.0% -6.2% -13.9% -7.2%
Total FMCG 40.5% 38.3% 41.5% 39.7%
Hotels 31.4% 31.7% 31.5% 31.6%
Paperboards, paper & packaging 23.3% 22.4% 23.1% 20.4%
Agri business 5.4% 1.3% 4.8% 3.0%
Total PBIT 28.6% 28.0% 28.1% 26.9%

Other income driven: Higher other income and lower interest costs led to the bottomline growth of 13.4% YoY. However, the growth would have been more, but for higher tax rates. The effective tax rate increased from 29% in 2QFY07 to 32% in this quarter. The profits are marginally above our estimates.

What to expect?
At the current price of Rs 180, the stock is trading at a price to earnings multiple of 17.5 times our FY10 estimates. Lower volumes and higher taxes continue to affect ITC’s cigarette division. However, due to its diversified business, the company is expected to do well going forward. Also, given its expansion plans progressing well and entry into new segments, we have a positive view on the company.

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