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ITC: Not just cigarette! - Views on News from Equitymaster

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ITC: Not just cigarette!
Oct 30, 2006

Introduction to results
Diversified major, ITC has reported yet another quarter of strong performance. The company’s topline and bottomline have grown by 32.3% YoY and 18.7% YoY respectively during 2QFY07. The company has again been successful in de-risking its revenue model by increasing the share of its other businesses in the total revenue pie. However, higher raw material costs shrunk the operating margins by 390 basis points, which led to a much slower growth in bottomline.

Rs(m) 2QFY06 2QFY07 (%) Change 1HFY06 1HFY07 (%) Change
Net sales 21,832 28,876 32.3% 44,500 57,374 28.9%
Expenditure 13,633 19,149 40.5% 28,034 37,941 35.3%
Operating profit (EBDITA) 8,198 9,727 18.6% 16,466 19,433 18.0%
EBDITA margin (%) 37.6% 33.7%   37.0% 33.9%  
Other income 784 795 1.4% 1629 1644 0.9%
Interest - 35   11 42 288.9%
Depreciation 830 910 9.6% 1630 1786 9.5%
Profit before tax 8,152 9,578 17.5% 16,454 19,249 17.0%
Tax 2,429 2,782 14.5% 5,148 5,930 15.2%
Profit after tax/(loss) 5,723 6,796 18.7% 11,306 13,319 17.8%
Net profit margin (%) 26.2% 23.5%   25.4% 23.2%  
No. of shares (m) 2,503 3,757   2,503 3,757  
Diluted earnings per share (Rs)*         6.5  
Price to earnings ratio (x)         28.8  
* 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 2QFY07?
(%of gross sales) 2QFY06 2QFY07 1HFY06 1HFY07
Cigarettes 72.8% 67.1% 73.1% 67.6%
Others 6.6% 8.9% 5.9% 8.3%
Total FMCG 79.5% 75.9% 79.0% 75.9%
Hotels 4.1% 4.3% 4.0% 4.3%
Paperboards, paper & packaging 12.6% 11.3% 12.2% 11.1%
Agri business 12.5% 18.8% 16.0% 21.4%
Total turnover 108.7% 110.3% 111.2% 112.7%
Less: intersegment revenues 8.7% 10.3% 11.2% 12.7%
Gross sales 100.0% 100.0% 100.0% 100.0%

Not just cigarettes: ITC recorded a 32.3% YoY growth in topline during 2QFY07 led by robust growth in all businesses. Higher disposable incomes, both in urban and rural areas, drove the cigarette sales, which were up by 13.9% YoY. Agri business recorded a strong growth of 86.6% YoY, while revenues from paper & packaging segment rose by 11.1% YoY. ITC’s hotel business registered a sharp 30.5% YoY growth aided by strong tourist inflow and favourable demand supply gap in the country. ITC has been slowly and gradually lowering its dependence on cigarette (high margin) business and increasing its focus on the other businesses. The contribution of cigarette business to the total revenues has decreased to 68.8% compared to 73.2% in 2QFY06. Non-cigarettes FMCG business, which accounts for 31% of total sales, recorded a robust growth of 46% YoY during 2QFY0.

PBIT margin trend…
(% of segmental revenues) 2QFY06 2QFY07 1HFY06 1HFY07
Cigarettes 25.1% 25.4% 24.7% 25.6%
Others -14.3% -12.0% -20.1% -13.9%
Total FMCG 21.8% 21.0% 21.4% 21.3%
Hotels 17.9% 28.8% 27.8% 28.9%
Paperboards, paper & packaging 19.5% 21.2% 19.5% 21.1%
Agri business 6.6% 5.3% 5.5% 4.7%
Total PBIT 19.7% 18.7% 19.1% 18.4%

Higher raw material cost eating into margins: Operating profit for the year increased by 18.6% YoY. However, operating margins dipped by 390 basis points to 33.7% due to sharp 550 basis points increase in raw material cost. During 2QFY07, PBIT margins of the cigarette business expanded by 30 basis points to 25.4%. The hotel segment registered a sharp improvement of 10.9% while margins of paper business improved by 170 basis points. Margins have been impacted by the sharp dip in agri business profitability, which has been extremely volatile quarter to quarter.

Cost break-up
As a % of net sales 2QFY06 2QFY07 1HFY06 1HFY07
Total Cost of goods 37.1% 42.6% 37.8% 42.9%
Staff Cost 6.3% 5.2% 5.8% 5.3%
Other Expenditure 19.1% 18.5% 19.3% 18.0%

Bottomline story: The bottomline growth of 18.7%was lower than the topline performance due to the fall in the operating margins. Further lower other income did not aid the bottomline.

What to expect?
At the current price of Rs 187, the stock is trading at a price to earnings multiple of 28.8 times its 12-months trailing earnings. The strong traction in the cigarette business indicates continuing volume growth. Outlook for the non-cigarette businesses such as hotels and paper also remains positive with continued demand buoyancy. The other FMCG businesses too are witnessing strong growth. Though medium-term valuations look stretched, investors with long-term horizon can have ITC as part of their portfolio.

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