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ITC: 'Smoky' performance

Oct 29, 2004

Performance summary
Tobacco major, ITC, has reported 13% growth in its September quarter net sales. Its profits have clocked a similar growth rate during the said quarter. The company's margins have remained steady. Though the performance is encouraging, it is lower than the 24% topline growth it reported in the June quarter. Overall, the company has clocked over 18% topline and almost 15% bottomline growth in the first half of the current year.

(Rs m) 2QFY04 2QFY05 Change 1HFY04 1HFY05 Change
Gross sales 29,257 32,889 12.4% 57,383 65,829 14.7%
Net Sales 15,363 17,379 13.1% 29,651 35,128 18.5%
Expenditure 9,182 10,399 13.3% 17,350 21,173 22.0%
Operating Profit (EBDITA) 6,181 6,979 12.9% 12,301 13,955 13.5%
EBDITA margin (%) 40.2% 40.2%   41.5% 39.7%  
Other income 698 699 0.1% 1,269 1,277 0.6%
Interest (net) 40 100 151.8% 94 229 143.0%
Depreciation 599 703 17.3% 1,193 1,382 15.8%
Profit before Tax 6,241 6,875 10.2% 12,282 13,621 10.9%
Tax 1,962 2,019 2.9% 4,031 4,144 2.8%
Profit after Tax/(Loss) 4,279 4,857 13.5% 8,251 9,477 14.9%
Net profit margin (%) 27.9% 27.9%   27.8% 27.0%  
No. of Shares (m) 247.5 247.9   247.5 247.9  
Diluted Earnings per share (Rs)* 69.1 78.4   66.7 76.5  
Price to earnings ratio (x)         14.2  

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 biggest 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 48 Wills Lifestyle stores in 38 cities. Other initiatives include greeting cards (20% market share), safety matches and incense sticks.

What has driven performance in 2QFY05?
Sales:  Cigarettes (79% of 1HFY05 sales) led the performance with a consistent 11% growth (both in the September quarter and the first half). The company's FMCG business (comprising of retailing, foods, agarbattis, greeting cards etc.) grew by a strong 76%, but growth seems to be slowing down for this business. The revenues from this business had almost doubled in the June quarter. Hotels business benefited from the upturn in the industry's occupancy rate and grew by over 21% YoY. The performance has also to be viewed in the context that the industry is coming out of a bad trough. Paperboards (nearly 12% of turnover) clocked a strong 25% growth led by continued shift to speciality paperboards and capacity augmentation. The company's agri business (13% of sales) performance however, was staid during the quarter. This business had grown by a strong 39% in the previous quarter. The sluggishness in its agri business was the key reason in the company reporting a lower topline growth at 13%, as compared to 17% growth it witnessed in the June quarter.

Turnover snapshot
(Rs m) 2QFY04 2QFY05 Change 1HFY04 1HFY05 Change Sales mix
Cigarettes 22,843 25,412 11.2% 45,753 50,795 11.0% 78.7%
Others 749 1,319 76.2% 1,266 2,372 87.4% 3.7%
Total FMCG 23,592 26,732 13.3% 47,019 53,167 13.1% 82.4%
Hotels 566 686 21.1% 1,067 1,310 22.8% 2.0%
Paperboards, paper & packaging 3,082 3,855 25.1% 6,039 7,628 26.3% 11.8%
Agri business 4,029 4,030 0.0% 7,342 8,623 17.4% 13.4%
Total turnover 31,269 35,302 12.9% 61,466 70,727 15.1% 109.6%
Less: Inter segment revenues 2,711 3,112 14.8% 5,352 6,175 15.4% 9.6%
Gross sales 28,558 32,190 12.7% 56,115 64,553 15.0% 100.0%

Cost break-up
as % of sales 2QFY04 2QFY05 1HFY04 1HFY05
Material cost 34.2% 35.0% 32.9% 35.4%
Staff cost 5.9% 5.5% 6.2% 5.6%
Other exp. 19.6% 19.3% 19.4% 19.3%
Total expenses 59.8% 59.8% 58.5% 60.3%

ITC grew by 12% at the gross sales level. But increasing contribution of non-tobacco businesses to revenues (up from 9.3% in 1HFY04 to 11.7% in 1HFY05) led to a decline in the percentage of excise burden on gross turnover (down from over 48.3% last year to 46.6% in 1HFY05). Thus, net sales growth was faster than gross sales.

PBIT as a % of sales
(Rs m) 2QFY04 2QFY05 1HFY04 1HFY05
Cigarettes 22.9% 22.9% 23.1% 23.0%
Others -53.3% -35.5% -59.9% -36.3%
Total FMCG 20.5% 20.0% 20.9% 20.3%
Hotels 2.7% 13.8% 2.2% 13.0%
Paperboards, paper & packaging 20.0% 17.8% 19.0% 19.7%
Agri business 10.8% 11.8% 9.2% 8.5%
Total PBIT 18.9% 18.7% 19.0% 18.7%
Margins:  At the PBIT level, while cigarettes more or less maintained its margins, PBIT margins of the paperboards business fell by over 2%. Improvement is the hotels and agri business margins, as well as lower losses in other FMCG businesses like food processing, garment retailing, greeting cards, incense/match sticks etc. saw the company maintaining its overall operating margins. Hotel margins were low last year owing to Iraq concerns and also because the company's new hotel at Calcutta had just come on stream.

Net profit:  The company's increasing capex on hotels and paperboards capacity has led to higher depreciation provisioning. Interest costs too seem to have risen on account of higher debt levels. Combined with lower operating margins, these factors led to lower growth at the net profit level. The growth was nonetheless, encouraging.

What to expect?
At Rs 1,086 the stock trades at 14.2 times annualised 1HFY05 earnings and market cap. to gross sales of 2x. Though the company has reported 1HFY05 EPS numbers that are above our FY05 estimates, we would like to maintain the same owing to the fact that its agri exports business has shown signs of volatility in the past. Slowly but surely, ITC's other businesses are coming of age. The merger of ITC Hotels will also increase the non-tobacco revenues. Their contribution to overall PBIT is also improving. Overall, we are enthused by ITC's performance and believe that the company's non-tobacco initiatives are on track.

Over the last five quarters
  2QFY04 3QFY04 4QFY04 1QFY05 2QFY05
Net sales growth (YoY) 4.5% 10.6% 23.8% 24.2% 13.1%
Cigarette value growth (YoY) 3.5% 6.8% 7.1% 10.8% 11.2%
Excise as % of gross sales 47.5% 45.8% 43.1% 46.1% 47.2%
OPM (%) 40.2% 36.5% 28.6% 39.3% 40.2%
Net profit growth (YoY) 12.4% 17.7% 19.7% 16.3% 13.5%

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