ITC - Pricing power makes it smoking hot... - ICICIdirect

ITC, the undisputed leader in cigarettes in India, is our top pick in the FMCG segment. With ITC's strong pricing power in cigarettes, extensive distribution network and product launches in FMCG (keeping FMCG revenue growth at high teens), improvement in RoE from the hotel business and improving margins from paperboards business, we believe the stock is available at attractive valuations (22x FY16E EPS) providing a good entry point in the Rs. 310-325 range. We believe that with excise duty hike in cigarettes to moderate to ~10% in FY15E and FY16E, cigarettes volume growth would revive to ~2.5% by FY16E (-4% in FY14E). We value the stock on an SOTP basis, arriving at a target price of Rs. 387.

Market leadership to sustain cigarette margins

The strong pricing power in cigarettes (~80% market share by volume in FY12) has helped ITC pass on the higher excise impact (~18% in FY13 and ~21% in FY14) entirely through prices. Though volume growth was impacted in FY14E (-4%), premiumisation in cigarettes and increasing market share in 64 mm continued to aid its margins to 59.6% (FY13) and 64.8% (FY14E) from 56% (FY12). We believe that with excise hike moderating in FY15E and FY16E, thereby limiting price hikes, ITC's volume growth would revive to ~1% in FY15E and 2.5% in FY16E keeping margins intact at ~65% (FY16E) and EBIT contribution at +80%.

FMCG business gaining strength

ITC's relentless expansion in the FMCG business has almost doubled its revenues to Rs. 7012.4 crore in the past five years (FY08-13) with losses declining from Rs. 483.5 crore in FY09 to Rs. 45.2 crore in FY14E. This has been in spite of constant innovation and expansion into new segments and strengthening market share across categories. We expect FMCG to start contributing positively to EBIT from FY15E onwards.

Earnings growth to remain strong; valuations attractive

With earnings growth expected to remain healthy at 15.5% (CAGR FY13-16E) and the stock trading near its five-year average P/E multiple (oneyear forward) of 22x FY16E EPS, we believe ITC is attractively valued at CMP. We value the stock on SOTP basis arriving at a target price of Rs. 387.

Source : Equity Bulls

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