ITC INDIA – BUY

ITC reported a good quarter with strong performance across segments. As highlighted in our recent note (Time to ADD – Macro & micro turning favourable), we expect ITC (stock) to benefit from (1) expectation of Value (on current FCF profile basis) to outperform Growth/Expensive basket, (2) potential price hikes in cigarettes in the current inflationary environment (better consumer acceptance likely), (3) good underlying performance in the FMCG business along with higher profit (& EVA) focus, and (4) improving outlook for the hotels business (likely cyclical upturn).

Besides, focus continues on augmenting (overall) distribution. We see (1) potential market share gains in cigarettes, (2) FMCG scale-up and profitability improvement to continue and (3) potential to accelerate cost savings through a supply chain recast. Reiterate ADD; TP Rs260.

Cigarette volume rose 12% YoY in 3QFY22 (our view) which we believe was led by market share gains – management has indicated improved in-market performance. FMCG revenues grew 9.3% YoY with management using multiple levers to offset inflationary pressure; performance in discretionary and OOH categories recovered well. Hotels business did well and turned back to green. Agri business and paperboards also reported good performance.

• Cigarette volumes grew ~12% YoY: Overall revenue grew 33% YoY with the agri- business driving much ahead of expected print. Overall EBITDA was up 18% YoY while PAT grew 13% YoY (5% ahead of I-Sec estimate Cigarette gross revenues grew 14% YoY, with volume growth of 12% (2-year CAGR:
  +2.1%). We believe ITC has likely gained share with management highlighting that the performance was on the back of improved mobility and better market servicing. ITC has also strengthened its product portfolio with new launches. Cigarettes EBIT was up 14% YoY to Rs39.5bn, highest in a quarter.
• FMCG profitability print good despite inflationary pressure: FMCG revenues  grew 9.3% YoY. Management highlighted that (1) Hygiene products saw moderation in demand on sequential basis, (2) Staples and Convenience Foods posted good performance led by Sunfeast biscuits, spices and salt and (3) Discretionary and OOH product posted strong growth (on YoY basis) on a weak base though. Segment EBITDA margins were down 50bps YoY; it highlighted inflationary RM was offset by price hikes, premiumisation and cost management initiatives.
• Good performance in all other segments: Hotels business continued to recover  well with revenues rising 2.0x to Rs4.7bn and up 61% on a sequential basis; we note that it is still lower by 14% compared to Q3FY20 high. Management highlighted strong demand for leisure destinations and festive/wedding season. EBIT for hotel business turned green for the first time after the Covid impact – profit of Rs506mn compared to a loss of Rs673mn in 3QFY21. Several cost initiative measures introduced to strengthen the performance and offset the impact of negative operating leverage should help going forward.
• Paperboards segment also had a good quarter with revenue growth of 57% YoY and a strong EBIT margin print of 21.9%. Agri business posted a stellar quarter with revenue rising 2x to Rs49.6bn – easing supply chain networks led to this strong growth. EBIT margin was lower at 6.0% (versus 7.9% in Q3FY21).
• Valuation and risks: Our earnings estimates are largely unchanged for FY23. Maintain ADD with a DCF-based revised target price of Rs260 (Rs250 earlier). At our target price, the stock will trade at 18x P/E multiple Sept’23E. Key downside risk is tax hikes much ahead of inflation leading to volume pressure (on cigarettes) as price elasticity is still unfavourable.

Table 1: Q3FY22 result review

(Rs mn)