ITC - Improving trajectory (cigarette volumes, disclosures) = likely rerating potential exists - ICICI Securities

Cigarette volume declined ~12% in 2QFY21, due localised lockdowns in July'20 and Aug'20 and temporary disruption in certain wholesale markets while the product mix deteriorated driven by relatively more impact in South India, Metros and larger towns. Importantly, we see opportunity for ITC to reverse the market share loss - (1) increased activity in DSFT segment (offers focused on select markets) and (2) innovation at the premium-end (new formats and variants launched). As expected, other-FMCG profits continue to improve (TTM segment EBIT at Rs 6.3 bn) driven by improving profitability of extant categories. Consensus will view the increased disclosure levels (first ever quarterly results presentation, in our view - link) as a positive. Potential market share gains in cigarettes, FMCG scale-up (+profitability improvement) are positives. ADD.

- Cigarette volume declined 12%: Revenue / EBITDA / PAT declined 4% / 11% / 20%. Cigarette revenues declined 4% YoY on a reported basis, driven by ~12% volume decline. However, adjusting for tax change in Feb'20 (NCCD increase), cigarettes net revenue declined 15% YoY and EBIT margin declined 20bps YoY to 75%. This was due to localised lockdowns in July'20 and Aug'20, relatively more impact on South India, Metros and larger towns, and temporary disruption in certain wholesale markets. ITC looks to mitigate this supply chain impact by (1) enhancing service frequency for identified wholesalers, (2) strengthening direct reach in target markets, and (3) augmenting stockist network in rural/semi-urban markets.

- FMCG margin expansion continued: FMCG revenues grew 15% YoY on a reported basis. Adjusting for the Lifestyle retailing business restructuring and stationery products (impacted due to closure of educational institutes), revenue grew 18%. Staples, Convenience Food and Health & Hygiene products (75% revenue contribution) recorded 25% growth while discretionary categories and products with out-of-home consumption nature declined just 2%. Segment EBIT continued its upward trajectory (+180% YoY), improving 390bps YoY to 6.7% (EBITDA margin came in at 9.7%). Even on a trailing 12-month basis, EBIT margin has consistently improved to 4.6% as of Sept'20 vs. 0.3% as of Mar'17. We remain positive of the segment's margin expansion in the medium-term.

- Other businesses' performance impacted by hotels: Agri business revenue grew 13% (driven by trading opportunities in Rice, Mustard, Coffee & Wheat) and EBIT margin declined 90bps to 8.6%. Hotels was severely impacted due to restrictions in travel and tourism - reported Rs 1.9bn EBIT loss. Papers revenue declined 7% and EBIT declined 7% YoY while EBIT margins were flattish despite pricing pressure and negative operating leverage.

- Other highlights for FMCG business: (1) Highest ever quarterly sales for all FMCG businesses excluding stationery products, (2) Staples, Noodles posted robust growth, (3) Essential products & 'at-home' consumption witnessed moderation; remain at elevated levels though, (4) Strong traction continued for Hygiene segment, (5) Snacks regained traction with increased mobility, (6) Sequential improvement in Deodorants, Confectionery & Juices; still significantly below pre-Covid levels and (7) Over 70 innovative products launched in H1 - hygiene, health & wellness, naturals, convenience.

- Valuation and risks: We cut our FY22 earnings estimates by 9%; modelling revenue / EBITDA / PAT CAGR of 5 / 3 / -1 (%) respectively over FY20-22E. Maintain ADD with a DCF-based revised target price of Rs200 (was Rs220). At our target price, the stock will trade at 17x P/E multiple Sep'22E. Key downside risk is tax hikes much ahead of inflation leading to volume pressure (on cigarettes) as price elasticity is still unfavourable.

Shares of ITC LTD. was last trading in BSE at Rs.188.65 as compared to the previous close of Rs. 187.05. The total number of shares traded during the day was 389560 in over 7359 trades.

The stock hit an intraday high of Rs. 190 and intraday low of 188. The net turnover during the day was Rs. 73663588.

Source : Equity Bulls

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