Result Update October 28, 2016

Rating matrix Rating : Buy ITC Ltd (ITC) | 243 Target : | 277 Target Period : 12 months Potential Upside : 14% volumes back on track...

• ITC reported 7.8% YoY growth in revenue for Q2FY17 to | 13491.4 What’s changed? crore (I-direct estimate: | 14,288.7 crore). The company witnessed Target Unchanged EPS FY17E Changed from | 8.8 to | 8.7 7.1% YoY growth in cigarette business. FMCG segment grew EPS FY18E Changed from | 10.0 to | 9.7 strongly by 13.3% YoY largely driven by volumes supported by Rating Unchanged brand building and consumer/trade promotion activities. Hotels & agri business grew moderately by 2.5% and 2.0%, respectively; Quarterly performance however, paperboard remained flat | crore Q2FY17 Q2FY16 YoY (%) Q1FY17 QoQ (%) • Our estimates suggest cigarette volume growth in the quarter was Sales 13491.4 12511.8 7.8 13156.7 2.5 ~3-4% YoY and cigarette price hike was ~3%, which was lower than EBITDA 3630.0 3382.7 7.3 3526.2 2.9 our annual estimate of 10%. The company is consciously increasing EBITDA (%) 26.7 26.8 -16 bps 26.6 5 bps PAT 2500.0 2262.5 10.5 2384.7 4.8 the contribution 64 mm due to lower tax incidence. • EBITDA margin remained largely flat on YoY basis to 26.7%. Other Key financials income grew substantially by 21.1% YoY leading to a 10.5% YoY | Crore FY15 FY16 FY17E FY18E growth in profit to | 2500.0 crore (I-direct estimate: | 2737.6 crore) Revenue 36,083.2 51,582.5 55,862.9 62,711.6 Cigarette volume growth bounced back in FY17E EBITDA 13,473.6 13,717.9 15,134.2 17,064.0 Net Profit 9,607.7 9,311.3 10,501.2 11,746.7 ITC, the undisputed leader in cigarettes (~75% volume share), has been EPS (|) 8.0 7.7 8.7 9.7 witnessing moderation in volume growth since FY14. The strain on *From FY16 onwards, financials are reported as per Ind AS volumes (-9% in FY15) was largely led by incessant price hikes taken to pass on increasing excise duty (~16% in 2014 Budget & ~15% in 2015 Valuation summary Budget in above 65 mm category). In 2014 & 2015 Budget, excise hike on FY15 FY16 FY17E FY18E 64 mm segment was ~115% cumulatively, further compounded by VAT P/E 30.4 31.4 27.8 24.9 hike in Tamil Nadu, Kerala, Maharashtra and UP. Budget 2016 witnessed Target P/E 34.8 35.9 31.9 28.5 increase of 10% in excise on cigarettes irrespective of length of the stick. Div. Yield 2.6 3.5 3.0 3.0 Mcap/Sales 8.1 5.7 5.2 4.7 However, the magnitude of excise increase for cigarettes in particular is RoNW (%) 31.3 28.7 31.6 34.7 not as steep compared to prior excise hikes. ITC took selective price RoCE (%) 43.4 42.2 45.2 49.1 increases across its cigarettes portfolio (prices hiked for Classic & Gold *From FY16 onwards, financials are reported as per Ind AS Flake Kings brands by up to 13% post Budget 2016) to pass on excise increase. Considering the excise hike in Budget is not as aggressive as Stock data previous hikes & creation of low base for last couple of years, we expect Particular Amount 3% & 2% growth in cigarette volumes for FY17E & FY18E respectively. Market Capitalization (| Crore) 292,113.4 Total Debt (FY16) (| Crore) 29.4 Opportunities galore for the company in packaged foods segment Cash and Investments (FY16) (| Crore) 12,491.8 ITC’s growth in FMCG segment has been phenomenal at 18.5% CAGR in EV (| Crore) 279,651.0 FY08-16. ITC’s branded packaged food segment reported sales of | 52 week H/L 266 / 179 7097.5 crore in FY16 out of total FMCG segmental sales of | 9731.2 crore. Equity capital | 1207.1 crore & Sunfeast are now brands with annual sales of over | 3000 Face value | 1 crore & | 2500 crore respectively. Classmate & Bingo are | 1000+ crore Price performance brands. It also entered dairy segment with the launch of Aashirvaad 1M 3M 6M 12M Svasti ghee and Sunfresh dairy whitener in FY16. We believe ITC remains ITC -5.0 -3.4 11.1 1.0 one of the key beneficiaries in terms of change in consumption patterns HUL -6.7 -6.0 -4.0 6.1 shifting from unorganised to organised sector, going forward. Thus, we Nestle 6.1 -3.1 15.0 8.2 remain positive on ITC’s non-cigarette FMCG business in general and its VST Industries 3.1 24.2 41.5 44.4 branded packaged food business in particular. We model revenue CAGR of 13.1% in FY16-18E clocking revenues of | 12438.2 crore by FY18E. Research Analyst Cigarette volume growth back in positive territory; maintain BUY Sanjay Manyal We believe the cigarettes business would witness some relief on the [email protected] volumes front in the near term mainly due to the 10% excise hike in Tejashwini Kumari Budget 2016, which the company would be easily able to pass on to the [email protected] consumers in the form of strategic price increases. We believe ITC’s focus on growing its FMCG business by entering newer segments and tapping opportunity in foods segment would be a catalyst for topline growth in the long run. We maintain positive stance with a target price of | 277.

ICICI Securities Ltd | Retail Equity Research

Variance analysis Q2FY17 Q2FY17E Q2FY16 YoY (%) Q1FY17 QoQ (%) Comments Net Sales 13,491.4 14,288.7 12,511.8 7.8 13,156.7 2.5 Net sales witnessed a growth of 7.8% YoY to | 13491.4 crore mainly led by 13.3% growth in FMCG and 7.0% growth in cigrettes business Operating Income 125.2 131.9 99.5 25.8 96.4 29.9

Raw Material Expenses 3,671.4 4,132.8 3,113.5 17.9 4,245.6 -13.5 Employee Expenses 600.3 671.6 578.1 3.9 700.3 -14.3 Other operating Expenses 1,759.0 1,457.5 1,724.6 2.0 1,581.9 11.2

EBITDA 3,630.0 4,004.1 3,382.7 7.3 3,526.2 2.9 EBITDA Margin (%) 26.7 27.8 26.8 -16 bps 26.6 5 bps EBITDA margins remained flat. Margins looks optically lower due to change in accounting standard Depreciation 268.4 260.1 258.2 4.0 261.3 2.8 Interest 10.7 11.6 10.3 4.0 10.1 6.1 Other Income 475.4 408.4 392.6 21.1 420.5 13.0

PBT 3,826.2 4,140.7 3,506.8 9.1 3,675.4 4.1 Tax Outgo 1,326.2 1,403.1 1,244.3 6.6 1,290.7 2.7 PAT 2,500.0 2,737.6 2,262.5 10.5 2,384.7 4.8 21% increase in other income aided 10.1% YoY growth in PAT

Key Metrics YoY growth (%) Cigarette Growth (%) NA NA 1.6 6.4 FMCG (Others) Growth (%) 13.3 14.0 7.1 620 bps 9.5 380 bps Grew strongly by 13.3% supported by enhanced scale and sales mix to offset impact of increase in input cost, continued investment in brand building and promotion activities Hotels Growth (%) 2.5 NA 10.9 -840 bps -0.2 270 bps Agri Business Growth (%) 2.0 16.0 -10.4 1240 bps 20.2 -1820 bps Muted growth of 2.0% YoY growth led by domestic sales. Export continued to remain impacted Paperboards Growth (%) 0.0 15.0 -2.3 230 bps -1.6 160 bps remained flat Source: Company, ICICIdirect.com Research

Change in estimates FY17E FY18E (| Crore) Old New % Change Old New % Change Comments Sales 57,964.4 55,862.9 -3.6 64261.6 62711.6 -2.4 Due to marginal cut in the cigarette revenue estimates EBITDA 15,595.4 15,134.2 -3.0 17181.3 17064.0 -0.7 EBITDA Margin (%) 26.7 26.9 13 bps 26.5 27.0 47 bps PAT 10,606.7 10,501.2 -1.0 12032.1 11746.7 -2.4 EPS (|) 8.8 8.7 -1.0 10.0 9.7 -2.4

Source: Company, ICICIdirect.com Research

Assumptions Current Earlier Comments FY15E FY16E FY17E FY18E FY16E FY17E FY18E Cigarettes (| cr) 30,452.4 32,348.3 35,666.4 38,561.9 32,348.3 36,012.5 40,404.6 We have marginally tweaked our cigarette volume assumptions downwards considering the H1FY17 performance

Cigarette Vol. Growth (%) -9.0 -10.0 3.0 2.0 -10.0 4.0 2.0 Cigarette Price Growth (%) 21.2 12.0 7.0 6.0 12.0 7.0 10.0 FMCG - Others (| cr) 9,038.0 9,731.2 11,124.7 12,438.2 9,731.2 11,000.5 12,299.2 Hotels (| cr) 1,187.0 1,286.2 1,459.4 1,491.4 1,286.2 1,399.2 1,490.4 Agri Business (| cr) 8,380.5 7,456.9 8,963.4 9,664.5 7,456.9 8,792.5 9,482.1 Paperboards (| cr) 5,281.6 5,327.7 5,785.5 6,257.4 5,327.7 5,741.1 6,199.0

Source: Company, ICICIdirect.com Research

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Quarterly Highlights • FMCG – Others grew strongly by 13.3% during the quarter amidst weak demand conditions supported by enhanced scale and sales mix to offset impact of increase in input cost, continued investment in brand building and promotion activities. • New launches: Aashirvaad Sugar Release Control Atta, Bingo! Yumitos Original Style, new variants under the Engage brand • The company strengthened its presence in the north-east market by leveraging its biscuits manufacturing facility at Mangaldoi, Assam (set up through a joint venture company, North East Nutrients Private Ltd.). • In dairy and beverages segment, company scaled up its sales of the ‘B Natural’ range of juices and launched two blends of coffee under the ‘Sunbean’ brand – Nicamalai and Panagiri. • It expanded the footprint of Fabelle Chocolate Boutiques to ITC Sonar, Kolkata, ITC Maurya, New Delhi and ITC Grand Chola, . • The performance of the cigarette segment remained subdued on account of continued pressure on the legal cigarette industry in India and grew at a 7.1% YoY. We believe volume growth during the quarter was ~3-4% and price hikes were at 3% lower than our annual estimates of 10%. • Hotel segment grew marginally by 2.5% YoY on account of continued subdued operating conditions of the domestic hospitality industry • Agri segment witnessed 2.0% YoY growth led by higher agri- commodity sales in the domestic market, however, the export continued to remain impacted due lower wheat output domestically and steep currency depreciation in competing geographies. • The paperboards, paper & packaging segment’s revenue was flat on YoY basis, however, the on account of improved product mix and benign input costs, there was improvement in the profitability from the segment. The company is setting up bleached chemical thermo mechanical pulp mill at its Bhadrachalam unit to reduce dependence on imported pulp. The mill is expected to be commissioned in H2FY17. It is also planning for capacity expansion in the value added paperboards and decor segments which will further improve the profitability.

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Company Analysis Cigarette volume growth expected to trend upwards in FY17E Being the leader in the Indian cigarette industry (brands: Gold Flake, Wills, Bristol, Scissors), ITC commands complete pricing power in the segment. The revenue growth of 12.4% (CAGR FY09-15) from cigarettes (~46.6% of revenues) has been led by 12.9% price led CAGR. Volume growth witnessed a setback in FY15 (-9%) following a cumulative price hike of ~16% and ~22% in FY14 and FY15, respectively. The significant price hikes taken by the company were on the back of ~18%, ~16% and ~15% increase in excise duty (on sticks above 65 mm) for FY14, FY15 and FY16, respectively. Further, led by the considerable increase in excise in above 65 mm sticks, cigarette companies forayed into the 64 mm segment to vary their sales mix. ITC has also extended its existing brands, Scissors, Bristol and in the 64 mm segment at | 5/stick to revive its volume growth and target downtrading consumers.

However, in the FY15 Budget, the government increased excise on all lengths of cigarettes for a fourth consecutive year by 11-72% (<64 mm segment by 72% and on all other length of cigarettes by 11-22%) in July 2014 and by 25% in <65 mm category and by 15% in >65 mm category. In Union Budget 2016, the government hiked excise on products other than bidis by 10-15%. However, the magnitude of excise increase for cigarettes, in particular is not as steep as prior excise hikes. Budget 2016 witnessed an increase of 10% in excise duty on cigarettes irrespective of the length of the stick. This is the fifth consecutive year of excise hike and ITC has passed on the excise increase by way of gradual price hikes in the past. It took selective price increases across its cigarettes portfolio (prices hiked for Classic & Gold Flake Kings brands by up to 13% post Budget 2016) to pass on the excise increase. Considering that the excise hike in Budget 2016 is not as aggressive as previous hikes & creation of low base for last couple of years, we expect 3% & 2% growth in cigarette volumes for FY17E & FY18E respectively coupled with 7% and 6% price hike respectively for the same period.

We believe ITC’s dominance in the cigarette segment in India would continue to aid its dominance in ITC’s EBIT at 80.5% until FY18E with EBIT growth from cigarettes remaining modest at 5% CAGR in FY16-18E.

Exhibit 1: Cigarette revenues, revenue growth (YoY) Exhibit 2: Cigarette volume growth (YoY)

40000 16.8 20 8 35000 14.3 14.7 6 30000 12.2 15 11.9 4 10.3 25000 9.3 2 20000 8.1 10 6.2 0 15000 4.7 -2 FY08 FY09 FY10 FY11 FY12E FY13E FY14E FY15E FY16E FY17E FY18E 10000 5 -4 5000 -6 0 0 -8 -10 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17EFY18E -12 Volume growth (%) Cigarette Revenues (| crore) - LHS Cigarette revenue Growth (%)

Source: Company, ICICIdirect.com, Research Source: Company, ICICIdirect.com, Research

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Exhibit 3: Cigarette EBIT (| crore) and cigarette EBIT growth (%)

14000 25 19.8 20.5 20.3 18.0 12000 16.8 20 14.6 15.1 10000 11.8 12.4 15 8000 10 6000 5.0 5 4000 -2.6 2000 0 0 -5 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17E FY18E

Cigarette EBIT (| crore) Cigarette EBIT Growth (%)

Source: Company, ICICIdirect.com Research

Aggressive expansion into packaged foods indicates its focus on FMCG ITC’s emerging strength is the FMCG (others) business led by robust growth of 20.1% CAGR (FY09-15) and strong brands like Aashirvaad, Sunfeast, Bingo, Candyman (branded packaged foods), Vivel, , Superia (personal care), Classmate, Paperkraft (education & stationery) and Wills Lifestyle & John Players (lifestyle retailing). Post strong growth of 21.9% CAGR during FY08-12, the revenue from the segment has been steadily growing at 15.1% CAGR (during FY12-16). The company’s constant endeavour to enter higher growth segments, especially in the branded packaged foods segment, has aided it to carve out a significant place for itself in the Indian FMCG markets with revenues of | 9704.4 crore in FY16. We believe ITC has an edge over other FMCG players in the segment led by its strong and established distribution network of cigarettes. We expect ITC’s presence in the segment to continue to grow at 13.1% revenue CAGR in FY16-18E led by further strengthening of its brand equity in established segments and entry into new segments (beverages and milk), going forward.

Recent acquisitions (B natural juices in May 2014, Savlon, Shower to Shower from Johnson & Johnson in February 2015) and new launches in FY16 (Sunfeast Farmlite All Good biscuits, entry into premium chocolates segment with Fabelle, extension of B Natural beverage portfolio to nine variants) signal ITC’s intent to be one of the leading Indian FMCG players. ITC’s branded packaged food segment reported sales of | 7097.5 crore in FY16 out of total FMCG segmental sales of | 9731.2 crore. Aashirvaad & Sunfeast are now brands with annual sales of over | 3000 crore & | 2500 crore respectively. Classmate & Bingo are | 1000+ crore brands. It also entered dairy segment with the launch of Aashirvaad Svasti ghee and Sunfresh dairy whitener in FY16. We believe that ITC has been sharpening its focus on core FMCG business with foray into new product categories whilst strengthening its presence in existing ones. Thus, we remain positive on ITC’s non-cigarette FMCG business in general and its branded packaged food business in particular, given its strong brands as well as robust distribution network.

Despite growing at a healthy pace, the FMCG business has been able to achieve breakeven in FY15 since inception (2001) led by entry into new segments, year after year. However, losses have declined much faster than anticipated from | 483.5 crore (FY09) to | 81.3 crore (FY13) with marginal profit at | 70.5 crore in FY16, which we estimate to grow to

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|289.7 crore in FY18E. With the company’s brands gaining strength across segments and operational efficiency (back-end integration with ITC’s agri business and paperboards business) yielding positive results, we expect the FMCG business to increasingly contribute to profits in a staggered manner in FY17E and FY18E.

Exhibit 4: FMCG revenues (| crore) and growth (%) Exhibit 5: FMCG EBIT (| crore)

26.5 14000 30 400 289.7 23.1 23.7 176.0 12000 20.0 20.8 25 200 21.8 70.5 10000 15.8 34.1 14.3 20 8000 11.3 15.1 15 0 6000 7.7 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17E FY18E 4000 10 -200 -81.3 2000 5 -400 -195.5 0 0 -297.6 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17EFY18E -600 -483.5 -349.5

Revenues (| crore) Revenue Growth (%) EBIT (| crore)

Source: Company, ICICIdirect.com, Research Source: Company, ICICIdirect.com, Research

Hotels remain drag on return ratios ITC’s hotel business (2.5% of revenues FY16) has remained a drag on return ratios given the huge capital employed in the segment (~| 4475 crore FY16) and earnings (EBIT) remaining subdued (| 55.7 crore in FY16). With the company actively investing in the segment, we expect upcoming new properties along with gradually improving occupancy levels to aid revenue growth albeit at a modest rate of 7.7% CAGR in FY16-18E. Going forward, we do not expect any significant turnaround in the business with earnings from the segment improving marginally to | 178.4 crore by FY18E.

Exhibit 6: Hotel revenues (| crore) and growth (%) Exhibit 7: Hotel EBIT (| crore)

13.5 316.2 1500 15 350 279.4 1200 8.4 12 300 266.6 6.8 900 9.9 9 4.8 250 216.6 600 2.2 6 210.5 178.5 200 137.7 300 0.5 5.4 3 150 139.7 0 0 55.7 100 49.1 -300 FY09-7.3 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17EFY18E -3 -600 -6 50 -900 -9 0 -1200 -10.7 -12 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17E FY18E

Revenues (| crore) Revenue Growth (%) EBIT (| crore)

Source: Company, ICICIdirect.com, Research Source: Company, ICICIdirect.com, Research

Slowdown in cigarettes & FMCG, cheaper imports impacting paperboards ITC’s paperboards business (10.3% of revenues in FY16) posted modest revenue CAGR (FY08-15) of 12.2% led by 8% volume CAGR and ~4% price led CAGR. With ITC being the leader in the paperboards and speciality papers segment and the company increasing its capacity in the segment (brownfield expansion in Bhadrachalam, Andhra Pradesh) we expect ITC’s dominance to strengthen further. The company is setting up a pulp mill at its Bhadrachalam unit to reduce dependence on imported

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pulp, which is expected to be commissioned in H2FY17. It is also planning for capacity expansion in the value added paperboards and decor segments which will provide better profitability. Thus, we estimate the profitability from the segment to improve, though we are factoring moderate growth in the segment at 8.4% CAGR in FY16-18E.

Exhibit 8: Paperboards revenues (| crore) and growth (%) Exhibit 9: Paperboards EBIT (| crore) 1434.3 6500 25 1400 1109.2 19.4 1200 5200 20 964.0 907.6 14.7 892.5 14.6 13.4 1000 936.8 921.5 12.6 819.2 3900 15 800 9.1 8.6 8.2 684.3 2600 10 600 508.6 2.2 400 1300 0.9 5 200 0 0 0 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17E FY18E

Revenues (| crore) Revenue Growth (%) EBIT (| crore)

Source: Company, ICICIdirect.com, Research Source: Company, ICICIdirect.com, Research

Treading into new frontiers with clear long term vision ITC has been aggressive in recent times to shape itself into India’s leading FMCG company. It has set before itself an ambitious vision of achieving a topline of | 100000 crore from non-cigarette FMCG business by 2030. This translates to a CAGR of 17.4% in this segment in FY15-30E. After starting the FMCG business from scratch in 2001, it had a topline of | 9731.2 crore from this segment in FY16. Further, ITC’s foods portfolio, on the back of strong brands like Sunfeast, Aashirvaad, Yippee, alone accounted for over | 7000 crore of sales in FY16. ITC ventured into new business of dairy products with the launch of Aashirvaad Svasti cow ghee, luxury chocolates under Fabelle and dairy whitener segment under Sunfresh. We believe it would continue to leverage the brand equity of its prominent brands by driving line extensions. Additionally, the expanse of opportunities for the company can be gauged from the untapped potential in the organised wheat flour market, which is estimated at ~| 7500 crore. India’s wheat production was at ~86.5 million tonnes in 2015. Of this, organised wheat flour market size is ~2.5 million tonnes while unorganised sector has a market share with ~12.5 million tonnes. This translates to a potential market size of ~| 46000 crore. Thus, the organised wheat flour market currently constitutes ~16% of this potential size. With growing urbanisation and changing lifestyles of Indian households, if consumers shift to organised wheat flour, taking 16% to ~50% levels in the next four or five years, then the expected organised wheat flour market size comes to ~| 23000 crore. ITC (Aashirvaad atta) is expected to be the major beneficiary by virtue of its current market of ~40%. This may translate into 3x growth to ~| 9000 crore for the company from branded wheat flour category alone.

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Annual report analysis Company’s gross sales growth slowed down to 3.3% vis-à-vis 6% last year. The business environment was extremely challenging during the year on account of a) pressure on the legal cigarette industry due to the cumulative impact of steep increase in taxation and regulatory pressures, b) sluggish demand and price deflationary conditions in the FMCG space coupled with start-up costs relating to new products and categories, c) hotels segment facing challenges due to excess room inventory and gestation costs of new properties, d) Agri exports were impacted due to higher crop output and steeper currency depreciation in competing regions, and lastly e) the paperboards, paper and packaging segment faced a weak demand and pricing environment.

A. Cigarette: impacted by excise duty and illegal trade Cigarette segment’s gross revenue grew by 6.2% during the year amidst challenging environment. Over the last 4 years, the excise duty and VAT on cigarettes has gone up cumulatively by 118% and 142% respectively at a per unit level, leading to pressure on demand for branded cigarettes and inturn increasing the demand for the illegal cigarettes. Though the company expects the operating environment for the legal cigarette industry to remain challenging in going ahead too on account of a) high levels of taxation, b) rising illegal trade and c) increasing regulatory pressures (graphic health warnings), it remains confident to sustain its leadership position in the legal cigarette industry. Fmcg – Others: The FMCG-Others segment, comprising of branded packaged foods, personal care products, education and stationery products, lifestyle retailing, incense sticks and safety matches grew by 7.7% for the year. It witnessed a slowdown due to a) curbing discretionary spending, b) headwinds in rural demand and c) increase in competitive intensity in the backdrop of decline in commodity prices. In addition to aforesaid reasons, the branded food Industry was further affected by regulatory issues in the Noodles segment which had an adverse rub-off effect on other related categories like snack foods. The company commissioned two manufacturing facilities for a) Finger Snacks at Dhulagarh, Bengal and d) Dairy at Munger, Bihar. It also commissioned a biscuits manufacturing unit at Mangaldoi, Assam through a JV company, North East Nutrients Private Limited.

B. Hotels Hotel segment’s revenue grew by 8.4% driven by improvement in room occupancy and robust growth in the Food & Beverage segment. However, headwinds like lower average room rates and addition of new rooms continued to be there which reflected in the profitability of the segment. Additionally, the impact of floods in Chennai, gestation costs of the recently commissioned ITC Grand Bharat, Gurgaon and higher depreciation charge due to revision in useful life of fixed assets further put pressure on the segment’s profitability.

C. Paperboards, paper and packaging The Paperboards, Paper and Packaging segment reported muted revenue growth by 0.9% and decline in profitability by 1.5% due to the the muted demand environment in the FMCG and Cigarette industry during the year. Additionally, zero duty on imports under the Free Trade Agreement (FTA) with ASEAN countries, coupled with cheaper imports from China continued to impact the domestic Paper and Paperboard industry. However, the overall demand is expected to grow at a CAGR of 6% over

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next five years with 6% growth in Paperboard segment (constituting 46% of the market) and 4% in Writing & Printing paper (constituting 31% of the market). D. Agri business

The agri business segment of the company which export of leaf tobacco and other agri commodities like rice and wheat. During the year this segment was under pressure owing to the continuation of decline in global cigarette demand due to steep hikes in taxation and the impact of stringent regulatory. Additionally, the food grain production in India is estimated to have declined by 12 million tonnes yoy in FY15 due to unseasonal rains and drought during 2014 & 2015 impacting both the Kharif and Rabi crops. Consequently, the company had not any material opportunity for exports during the year.

New Launches during FY16 Segment New Launches a) Classic Fine Taste - Low Smell, b) Noir - first 97mm super slim cigarette in the country, c) new and capsule filter offers and d) Cigarette EON with rechargable option in Delhi and Bengaluru a) Sunfeast Delishus Gourmet cookies - Chocolate Chip made with Ghana Cocoa, b) Sunfeast Farmlite Oats with Chocolate, c) Sunfeast Branded packaged foods Marie Light Rich Taste and d) Strawberry variant of Gum-on, e) ITC Master Chef (spices)

a) Fiama Di Wills Double Moisturiser Bathing Bar, b) Vivel Neem, c) Superia Silk Cherry bar soaps, d) Vivel Cell Renew brand for skin care Personal care products products like Makeup Cleanser, Toner and Night Cream and e) Engage Perfume Sprays in two variants each for men and women a) Several differentiated offerings under the Classmate, Classmate Pulse, Paperkraft and ‘Saathi brands, b) new range of Classmate Octane Education and stationery products pens and c) introduction of oil pastels and plastic crayons. Lifestyle retailing business New collections - Luxuria, Regalia and Ecostyle (natural- fibre products such as linens) under Wills Classic

Source: Company, ICICIdirect.com Research

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Outlook & valuation We believe that the cigarettes business would witness some relief on the volumes front due to 10% excise duty hike in budget 2016 (much lower than earlier years) and hence we are factoring 3% and 2% volume growth for FY17E and FY18E respectively. We believe company will be able to pass on the effect of increased excise duty to the consumers in the form of strategic price increases and factoring in 7% and 6% prices hikes for FY17E and FY18E respectively. Additionally, ITC’s focus on growing its FMCG business by entering newer segments and tapping opportunity in foods segment would be a catalyst for topline growth in the long run.

We reiterate our BUY recommendation on the stock and maintain our target price of | 277 valuing it on SOTP basis. We have valued the cigarettes business at | 208 (26x FY18E EPS), FMCG at | 37 (3.5x MCap/sales FY18E), paperboards at | 5 (3x FY18E EV/EBITDA), agri- business at | 6 (3x P/BV FY18E) and hotels at | 9 (2x EV/room FY18E) and have also added the cash per share of | 12.

Exhibit 10: Sum of the parts valuation

6 9 12 277 300 37 5 250 208

200

150

100

50

0 Cigarettes FMCG Paper Agri Hotels Cash per SOTP share

Source: Company, ICICIdirect.com Research

Exhibit 11: Valuations Sales Growth EPS Growth PE EV/EBITDA RoNW RoCE (| cr) (%) (|) (%) (x) (x) (%) (%) FY15 36083.2 21.9 8.0 29.5 30.4 21.1 31.3 43.4 FY16 51582.5 43.0 7.7 -3.1 31.4 20.9 28.7 42.2 FY17E 55862.9 8.3 8.7 12.8 27.8 18.8 31.6 45.2 FY18E 62711.6 12.3 9.7 11.9 24.9 16.8 34.7 49.1

Source: Company, ICICIdirect.com Research *From FY16 onwards, financials are reported as per Ind AS

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Recommendation history vs. Consensus

350 100.0 90.0 80.0 70.0 60.0

(|) 250 50.0 (%) 40.0 30.0 20.0 10.0 150 0.0 Oct-14 Dec-14 Mar-15 May-15 Aug-15 Oct-15 Jan-16 Mar-16 Jun-16 Aug-16 Oct-16

Price Idirect target Consensus Target Mean % Consensus with BUY

Source: Bloomberg, Company, ICICIdirect.com Research

Key events Date Event Feb-10 The GoI reduces excise duty on < 64 mm cigarettes by ~23% while increasing the excise on above 64 mm cigarettes by ~14% for its FY11 Budget Dec-10 ITC shuts all its five cigarette manufacturing units awaiting clarity from the government on the pictorial representation of packs Feb-11 The GoI leaves excise duty unchanged in its FY12 Budget; a key positive for the company Feb-12 GoI increases basic excise duty on cigarettes by whopping 20% in its FY13 Budget Sep-12 Inaugurates its largest luxury hotel, Grand Chola, in Chennai. It has a capacity of ~600 rooms Dec-12 Begins the construction of milk processing unit in Munger, Bihar Feb-13 The GoI in its Budget again raises the basic excise duty on cigarettes by 18% May-13 For the first time during the quarter the company reports a profit in its FMCG (others) business Jul-14 GoI increases excise duty on cigarettes for a third consecutive year. It announces an increase of 11-72% in excise duty in its FY15E Budget Oct-14 Health Ministry proposes ban on loose cigarettes, higher penalty on in public places Dec-14 Volume declines significantly in Q3FY15 as excessive price hike in last two years impacts growth Feb-15 Acquisition of Shower To Shower, Savlon brands from Johnson & Johnson Feb-15 Excise hike of 25% in below 65 mm category & 15% in above 65 mm category in Budget 2015 Feb-16 Excise hike of 10% on cigarettes in Budget 2016

Source: Company, ICICIdirect.com Research

Top 10 Shareholders Shareholding Pattern Rank Name Latest Filing Date % O/S Position (m) Change (m) (in %) Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 1 British American Tobacco PLC 30-Jun-16 24.58 2,978.3 0.0 Promoter----- 2 Myddleton Investments Co., Ltd. 30-Sep-16 24.58 2,978.3 2,492.0 FII 20.7 20.8 20.5 20.6 20.8 3 Life Insurance Corporation of India 30-Sep-16 14.30 1,732.6 0.0 DII 35.1 35.3 35.2 35.1 34.9 4 UTI Asset Management Co. Ltd. 30-Sep-16 11.10 1,345.1 0.0 Others 44.2 43.9 44.4 44.4 44.2 5 Rothmans International Enterprises, Ltd. 30-Sep-16 5.29 641.3 486.3 6 The New India Assurance Co. Ltd. 30-Sep-16 1.78 215.2 -2.7 7 General Insurance Corporation of India 30-Sep-16 1.77 214.3 -0.2 8 Oriental Insurance Company Ltd. 30-Sep-16 1.47 177.6 -2.4 9 Vontobel Asset Management, Inc. 31-Aug-16 1.30 157.3 -4.2 10 GIC Private Limited 30-Sep-16 1.25 151.9 -4.9

Source: Reuters, ICICIdirect.com Research

Recent Activity Buys Sells Investor name Value Shares Investor name Value Shares Myddleton Investments Co., Ltd. 9038.11m 2492.04m Bessemer Trust Company, N.A. (US) -29.97m -9.19m Rothmans International Enterprises, Ltd. 1763.76m 486.31m GIC Private Limited -17.68m -4.87m Capital Research Global Investors 106.76m 29.44m Vontobel Asset Management, Inc. -16.29m -4.2m Aberdeen Asset Management (Asia) Ltd. 25.52m 6.57m The New India Assurance Co. Ltd. -9.82m -2.71m Columbia Threadneedle Investments (US) 22.42m 6.18m Oriental Insurance Company Ltd. -8.68m -2.39m

Source: Reuters, ICICIdirect.com Research

ICICI Securities Ltd | Retail Equity Research Page 11

Financial summary

Profit and loss statement | Crore Cash flow statement | Crore

FY15 FY16 FY17E FY18E (Year-end March) FY15 FY16 FY17E FY18E

Total operating Income 36,507.4 51,944.6 56,364.6 63,177.6 Profit After Tax 9,607.7 9,311.3 10,501.2 11,746.7 Growth (%) 9.8 42.3 8.5 12.1 Add: Depreciation 961.7 1,031.9 1,027.3 1,291.5 Raw Material Expenses 14,672.0 13,450.0 15,991.4 16,561.1 (Inc)/dec in Current Assets 1,272.9 -1,204.4 -6,917.0 -2,830.4 Employee Expenses 1,780.0 2,328.3 2,542.5 2,822.0 Inc/(dec) in CL and Provisions 177.6 2,906.0 2,400.6 1,910.9 Marketing Expenses 930.4 0.0 906.2 815.3 CF from operating activities 12,020.0 12,044.8 7,012.0 12,118.9 Administrative Expenses 2,127.4 0.0 614.1 1,693.2 (Inc)/dec in Investments 70.5 -3,951.3 4,158.4 -170.9 Other expenses 2,633.6 7,086.5 5,766.3 5,016.9 (Inc)/dec in LT loans & advances -26.3 -779.1 -50.0 -50.0 Total Operating Expenditure 23,033.9 38,226.6 41,230.4 46,113.7 (Inc)/dec in Fixed Assets -2,945.9 -1,444.7 -549.9 -2,620.0 EBITDA 13,473.6 13,717.9 15,134.2 17,064.0 Others 336.6 224.9 20.0 0.0 Growth (%) 8.2 1.8 10.3 12.8 CF from investing activities -2,565.1 -5,950.1 3,578.5 -2,840.9 Depreciation 961.7 1,031.9 1,027.3 1,291.5 Issue/(Buy back) of Equity 6.2 3.2 402.4 0.0 Interest 57.4 49.1 45.3 46.8 Inc/(dec) in loan funds -12.3 -12.9 5.0 10.0

Other Income 1,543.1 1,769.3 1,803.7 1,829.8 Dividend paid & dividend tax -5,999.0 -8,181.6 -10,578.0 -10,578.0 PBT 13,997.5 14,406.1 15,867.2 17,555.5 Inc/(dec) in Sec. premium 0.0 0.0 0.0 0.0 Others Others -9.3 11.5 13.8 14.9 Total Tax 4,389.8 5,094.9 5,366.0 5,808.7 CF from financing activities -5,155.7 -7,652.8 -9,620.4 -11,089.6 PAT 9,607.7 9,311.3 10,501.2 11,746.7 Net Cash flow 4,299.2 -1,558.1 970.1 -1,811.6 Growth (%) 9.4 -3.1 12.8 11.9 Opening Cash 3,289.4 7,588.6 6,030.5 7,000.6 EPS (|) 8.0 7.7 8.7 9.7 Closing Cash 7,588.6 6,030.5 7,000.6 5,189.0 Source: Company, ICICIdirect.com Research Source: Company, ICICIdirect.com Research *From FY16 onwards, financials are reported as per Ind AS

Balance sheet | Crore Key ratios

(Year-end March) FY15 FY16 FY17E FY18E (Year-end March) FY15 FY16 FY17E FY18E Liabilities Per share data (|) Equity Capital 801.6 804.7 1,207.1 1,207.1 EPS 8.0 7.7 8.7 9.7 Reserve and Surplus 29,934.1 31,590.8 32,050.4 32,682.7 Cash EPS 8.8 8.6 9.6 10.8 Total Shareholders funds 30,735.7 32,395.6 33,257.5 33,889.7 BV 25.5 26.8 27.6 28.1 LT Borrowings & Provisions 38.7 25.8 30.8 40.8 DPS 6.3 8.5 7.3 7.3 Deferred Tax Liability 1,631.6 1,848.4 1,868.4 1,868.4 Cash Per Share 6.3 5.0 5.8 4.3 Others Non-current Liabilities 107.8 127.3 141.1 156.1 Operating Ratios (%) Total Liabilities 32,513.8 34,397.1 35,297.9 35,955.1 EBITDA Margin 36.9 26.4 26.9 27.0 Assets PBT / Total Operating income 38.3 27.7 28.2 27.8 Gross Block 20,990.8 21,868.4 23,368.4 25,368.4 PAT Margin 26.3 17.9 18.6 18.6 Less: Acc Depreciation 7,213.6 8,051.6 9,078.9 10,370.4 Inventory days 79.3 60.3 75.0 75.0 Net Block 13,777.1 13,816.8 14,289.5 14,998.0 Debtor days 17.4 11.9 12.0 12.0 Capital WIP 2,085.5 2,470.1 1,500.0 2,100.0 Creditor days 19.3 16.0 20.0 20.0 Net Intangible Assets 430.0 418.5 438.5 458.5 Return Ratios (%) Non-current Investments 2,441.6 6,392.9 2,234.5 2,405.4 RoE 31.3 28.7 31.6 34.7 LT loans & advances 1,506.4 2,285.4 2,335.4 2,385.4 RoCE 43.4 42.2 45.2 49.1 Current Assets RoIC 51.1 45.4 50.6 52.0

Inventory 7,836.8 8,519.8 11,478.7 12,885.9 Valuation Ratios (x) Debtors 1,722.4 1,686.4 1,836.6 2,061.8 P/E 30.4 31.4 27.8 24.9 Loans and Advances 549.9 501.8 1,224.4 1,374.5 EV / EBITDA 21.1 20.9 18.8 16.8 Other Current Assets 293.6 401.4 1,071.3 1,202.7 EV / Net Sales 7.9 5.5 5.1 4.6 Cash 7,588.6 6,030.5 7,000.6 5,189.0 Market Cap / Sales 8.1 5.7 5.2 4.7 Current Investments 5963.8 6461.3 8876.8 9793.3 Price to Book Value 9.5 9.0 8.8 8.6 Current Liabilities 11,681.9 14,587.9 16,988.4 18,899.4 Solvency Ratios Creditors 1,904.6 2,265.6 3,061.0 3,436.3 Debt/EBITDA 0.0 0.0 0.0 0.0 Provisions 6,106.1 8,318.6 9,336.0 10,308.8 Debt / Equity 0.0 0.0 0.0 0.0 Short term debt & other CL 3,671.2 4,003.7 4,591.5 5,154.4 Current Ratio 1.4 1.2 1.4 1.4 Application of Funds 32,513.7 34,397.1 35,297.9 35,955.1 Quick Ratio 0.7 0.6 0.8 0.8

Source: Company, ICICIdirect.com Research Source: Company, ICICIdirect.com Research

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ICICI Securities Ltd | Retail Equity Research Page 12

ICICIdirect.com coverage universe (FMCG)

CMP M Cap EPS (|) P/E (x) Price/Sales (x) RoCE (%) RoE (%) Sector / Company (|) TP(|) Rating (| Cr) FY16 FY17E FY18E FY16 FY17E FY18E FY16 FY17E FY18E FY16 FY17E FY18E FY16 FY17E FY18E Colgate (COLPAL) 937 971 Hold 26,402 21.2 22.1 27.0 44.2 42.3 34.7 6.4 5.6 5.0 77.6 71.5 75.6 58.7 50.1 52.9 Dabur India (DABIND) 291 338 Buy 2,975 7.1 8.0 9.4 40.9 36.3 31.1 6.96.25.631.129.730.130.227.927.9 GSK CH (GLACON) 6,028 6,765 Buy 25,965 163.3 171.7 190.9 36.9 35.131.66.05.55.039.436.435.828.126.326.1 Hindustan Unilever (HINLEV) 840 978 Buy 187,610 19.1 20.7 24.2 43.9 40.5 34.7 6.2 5.8 5.2 106.8 208.0 239.6 111.1 181.2 219.5 ITC Limited (ITC) 243 277 Buy 301,589 7.7 8.8 10.0 31.5 27.7 24.4 5.8 5.2 4.7 42.2 46.0 49.1 28.7 31.8 35.1 Jyothy Lab (JYOLAB) 359 397 Buy 6,463 5.0 10.0 12.3 71.6 36.0 29.1 4.1 3.8 3.3 19.2 18.2 21.4 8.8 16.3 18.9 Marico (MARIN) 278 323 Buy 37,738 5.6 7.0 8.4 49.6 39.9 33.1 6.3 5.7 5.0 46.2 49.3 49.4 34.5 37.3 38.0 Nestle (NESIND) 6,936 7,495 Buy 65,635 58.4 108.2 155.1 118.7 64.1 44.7 8.1 6.6 5.7 29.7 34.2 40.8 32.3 36.3 44.9 Tata Global Bev (TATTEA) 137 147 Hold 8,693 5.2 7.6 8.5 26.5 18.1 16.2 1.1 1.0 1.0 7.7 9.7 10.0 5.6 8.0 8.4 VST Industries (VSTIND) 2,382 2,437 Buy 3,166 99.2 117.0 135.4 24.0 20.4 17.6 3.6 3.2 3.0 59.7 67.4 70.6 41.3 45.4 49.1 Source: Company, ICICIdirect.com Research

ICICI Securities Ltd | Retail Equity Research Page 13

RATING RATIONALE ICICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assigns ratings to its stocks according to their notional target price vs. current market price and then categorises them as Strong Buy, Buy, Hold and Sell. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock.

Strong Buy: >15%/20% for large caps/midcaps, respectively, with high conviction; Buy: >10%/15% for large caps/midcaps, respectively; Hold: Up to +/-10%; Sell: -10% or more;

Pankaj Pandey Head – Research [email protected]

ICICIdirect.com Research Desk, ICICI Securities Limited, 1st Floor, Akruti Trade Centre, Road No 7, MIDC, Andheri (East) Mumbai – 400 093 [email protected]

ICICI Securities Ltd | Retail Equity Research Page 14

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ICICI Securities Ltd | Retail Equity Research Page 15