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ITC: Margins remain under pressure

Nov 4, 2014

ITC Limited has announced its second quarter results for financial year 2014-2015 (2QFY15). The company has reported 14.8% YoY growth in sales and 8.7% YoY increase in net profits. Here is our analysis of the results.

Performance summary
  • For 2QFY15, revenues grew by 14.8% aided by double-digit growth in all segments barring hotels and paper. During 1HFY15, topline grew by 19.6%.
  • But operating margin contracted by 1.7% due to sharp jump in cost of goods sold. For 1HFY15, the operating margin contracted by 2% YoY.
  • Net profit grew by a slower 8.7% due to write-back of liabilities towards Rates & Taxes and interest thereon in the year-ago quarter. For 1HFY15, the net profit was up by 11.9%.

(Rs. m) 2QFY14 2QFY15 Change 1HFY14 1HFY15 Change
Total income 78,625 90,237 14.8% 152,732 182,720 19.6%
Expenditure 46,866 55,351 18.1% 93,061 115,058 23.6%
Operating profit (EBITDA) 31,760 34,887 9.8% 59,672 67,662 13.4%
EBITDA margin (%) 40.4% 38.7% -1.7% 39.1% 37.0% -2.0%
Other income 2,462 3,562 44.7% 4,494 5,908 31.5%
Interest  -327 184   -157 335  
Depreciation 2,210 2,432 10.1% 4,362 4,745 8.8%
Profit before tax 32,339 35,833 10.8% 59,961 68,489 14.2%
Extraordinary inc/(exp) 0 0   0 0  
Tax 10,033 11,581 15.4% 18,742 22,374 19.4%
Profit after tax/(loss) 22,306 24,252 8.7% 41,219 46,116 11.9%
Net profit margin (%) 28.4% 26.9% -1.5% 27.0% 25.2% -1.7%
No. of shares (m)         7974  
Diluted earnings per share (Rs)*         11.6  
Price to earnings ratio (x)         30.7  
(* trailing twelve months)

What has driven performance in 2QFY15?
  • ITC clocked a 14.8% revenue growth in 2QFY15. In FMCG, the cigarette business recorded a growth of 14.2% led by higher realizations as offtake dropped by 4-5%. The non-cigarette FMCG business grew by 11.9% during the quarter. The agri business remained the fastest growing segment clocking a growth of 16% for the quarter driven by trading opportunities in wheat, soya and coffee. Among other businesses, the paper business recorded a growth of 9% aided by higher capacity utilization, better product-mix and scale-up in cartons and flexible pacakaging businesses. The hotel business remained a laggard posting a 5.9% growth in revenues in 2QFY15 on weak economic conditions.

    All round picture Sep 2014 quarter
       % contribution to sales  Revenue growth  PBIT growth  PBIT margin (%) PBIT margin gain/(decline) in basis points 
    Cigarettes 42% 14.2% 12.2% 67.8% -121
    Others 22% 11.9% -18.8% -0.5%  
    Total FMCG 64% 13.4% 12.3% 44.5% -42
    Hotels 3% 5.9% -209.9% -3.7%  
    Agri Business 20% 16.1% 4.8% 14.5% -157
    Paperboards, Paper & Packaging 13% 8.9% 9.7% 20.5% 335

  • High cost of goods sold continued to squeeze operating margin during the quarter. The cost of goods sold to sales ratio jumped up by 1.5%. Even other expense to sales ratio was up by 0.5%. the impact was partly neutralized by a 0.3% savings in staff costs in relation to sales. The operating margin contracted by 1.7% during the quarter. Only the paper business has been able to report incremental margin. Of 3.4%. The non-cigarette FMCG business has curtailed EBIT losses from 0.6% to 0.5% of sales.

  • Net profits grew by a subdued 8.7% due to write-back of liability towards Rates & Taxes and interest thereon of Rs 1.6 bn and Rs 347.7 m in the year-ago quarter. The tax incidence increased to 32% in 2QFY15 from 31% in 2QFY14.
What to expect?

ITC saw volume de-growth of 4-5% in cigarettes due to hike in excise duty implemented in Union Budget 2014. Sales growth has come mainly on account of the pricing power enjoyed by it. However, going ahead the business will continues to face headwinds on account of strict regulatory stance adopted by the government. Even its non-cigarette business continues to be loss-making.

At the current price of Rs 355, the stock trades at a P/E multiple of 24 times its estimated FY17 earnings. The current high valuations do not provide any significant upside. We would therefore recommend a SELL on stock at current levels.

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