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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)2QFY042QFY05Change1HFY041HFY05Change
Gross sales29,25732,88912.4%57,38365,82914.7%
Net Sales15,36317,37913.1%29,65135,12818.5%
Expenditure9,18210,39913.3%17,35021,17322.0%
Operating Profit (EBDITA)6,1816,97912.9%12,30113,95513.5%
EBDITA margin (%)40.2%40.2% 41.5%39.7% 
Other income6986990.1%1,2691,2770.6%
Interest (net)40100151.8%94229143.0%
Depreciation59970317.3%1,1931,38215.8%
Profit before Tax6,2416,87510.2%12,28213,62110.9%
Tax1,9622,0192.9%4,0314,1442.8%
Profit after Tax/(Loss)4,2794,85713.5%8,2519,47714.9%
Net profit margin (%)27.9%27.9% 27.8%27.0% 
No. of Shares (m)247.5247.9 247.5247.9 
Diluted Earnings per share (Rs)*69.178.4 66.776.5 
Price to earnings ratio (x)    14.2 
*(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 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)2QFY042QFY05Change1HFY041HFY05ChangeSales mix
Cigarettes22,84325,41211.2%45,75350,79511.0%78.7%
Others 7491,31976.2%1,2662,37287.4%3.7%
Total FMCG23,59226,73213.3%47,01953,16713.1%82.4%
Hotels56668621.1%1,0671,31022.8%2.0%
Paperboards, paper & packaging3,0823,85525.1%6,0397,62826.3%11.8%
Agri business4,0294,0300.0%7,3428,62317.4%13.4%
Total turnover31,26935,30212.9%61,46670,72715.1%109.6%
Less: Inter segment revenues2,7113,11214.8%5,3526,17515.4%9.6%
Gross sales28,55832,19012.7%56,11564,55315.0%100.0%

Cost break-up
as % of sales2QFY042QFY051HFY041HFY05
Material cost34.2%35.0%32.9%35.4%
Staff cost5.9%5.5%6.2%5.6%
Other exp.19.6%19.3%19.4%19.3%
Total expenses59.8%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)2QFY042QFY051HFY041HFY05
Cigarettes22.9%22.9%23.1%23.0%
Others-53.3%-35.5%-59.9%-36.3%
Total FMCG20.5%20.0%20.9%20.3%
Hotels2.7%13.8%2.2%13.0%
Paperboards, paper & packaging20.0%17.8%19.0%19.7%
Agri business10.8%11.8%9.2%8.5%
Total PBIT18.9%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
 2QFY043QFY044QFY041QFY052QFY05
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 sales47.5%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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