ITC - Regulatory concerns overplayed - HDFC Securities

Empirically, it is witnessed that in India it takes longer to enforce a law with regards to cigs (witnessed in implementing pictorial warning) as it contributes ~9% to indirect tax kitty. Global concern related to plain packaging, though accurate, we remain less bothered about it in near to medium term. We believe Indian cig to witness a vol growth of ~4-5% (bidi loosing share + natural growth + ban on chewing tobacco) over longer term as 64mm cigs provides an alternative to illicit cigs. FMCG business provides most exciting opportunity with it very near to break-even (expect to breakeven in 4QFY13E). We have conviction BUY on the stock with TP price of INR. 341.

Cig vol. to grow at ~4-5% CAGR over long term

With growing population, premiumisation (gradual shift from beedi to cigs) and regulatory ban on chewing tobacco in major states we anticipate cig volumes to grow at 4-5% CAGR over long term. Also, presence across price points and superior brand salience has helped ITC to gain share among domestic cig players (VST witnessed volume decline of ~15% yoy vis-à-vis growth of 1-2% yoy by ITC in 2QFY13). Furthermore, launch of the 64mm category can provide the volume push.

We also believe that plain packaging norm (adopted in Australia) is a legitimate long-term concern however, we remain less bothered about it in near to medium term as 1) Cigs constitute only 15% of total tobacco consumption, 2) India is stick based market, 3) general slow decision taking by government. We have experienced it while implementation of pictorial warning which took around 2 years after it was announced. We expect disruptive tax environment for cig in India to continue in absence of which volume growth to exceed estimates of 4-5%.

FMCG business to break even in 4QFY13

FMCG business reported negative EBIT of INR 303mn in 2QFY13E (down from INR 559mn EBIT loss in 2QFY12). We expect it to break even in 4QFY13E. Also, its food business (67% of FMCG business) is already profitable with its brands growing faster than category. We are enthused by its continuous investment in the brand building and plan to enter new categories (dairy, chocolates, etc).

Valuations

We Recommend BUY with SOTP based one year target price of INR 341. This implies 25x FY15E EPS which we believe is justified as FMCG likely to break even in 4QFY13 and its ability to retain margin in cigarettes in difficult scenario.

Source : Equity Bulls

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