Consumer Staples / ITC IN Consumer Staples / India 17 October 2013

ITC

ITC Target (INR): 270.00  392.00 Upside: 15.4% ITC IN 15 Oct price (INR): 339.80

Remains resilient 1 Buy • ITC continues to enjoy strong pricing power in its 2 Outperform (unchanged) business with little sales-volume backlash 3 Hold • Cigarette EBIT growth should be maintained at a high-teen 4 Underperform level; Other FMCG business should turn profitable from FY14 5 Sell • Raising target price to INR392: ITC remains our top pick in the consumer space, reaffirming Outperform

How do we justify our view?

months. On the back of these price ■ How we differ increases and cost-efficiency In this report we highlight potential initiatives in its cigarette division, cigarette price hikes by brand and we expect ITC’s EBIT margin to rise analyze their impact on EBIT growth.

for FY14. We forecast its Other Forecast revisions (%) Mihir Shah FMCG segment to turn profitable for Year to 31 Mar 14E 15E 16E (91) 22 6622 1020 a full year for the first time in FY14. Revenue change 5.1 n.a. n.a. [email protected] Net profit change 3.3 n.a. n.a. Core EPS (FD) change 1.1 n.a. n.a. We now forecast a 1% YoY sales- volume decline in for FY14 Source: Daiwa forecasts ■ What's new (6% YoY growth before) and expect ITC continues to demonstrate an the DSFT segment to aid in mitigating Share price performance ability to manage the bottom-line the volume decline. We forecast ITC’s (INR) (%) growth of its cigarette division by cigarette EBIT to rise by 18.2% for 380 125 350 116 achieving a fine balance between FY14 and 19.8% YoY for FY15. We 320 108 price rises and sales volume. We raise our FY14E EPS by 1.1%, expect ITC to remain one of the 290 99 reflecting higher sales. We forecast an 260 90 most resilient consumer companies EPS CAGR of 19.2% for FY13-16. Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 in India, insulated from the current ITC Ltd (LHS) Relative to SENSEX Index (RHS) weak economic environment. ■ What we recommend ITC remains our preferred pick in ■ What's the impact 12-month range 273.50-376.00 the consumer space. We raise our Market cap (USDbn) 43.70 ITC increased the weighted average six-month target price to INR392 3m avg daily turnover (USDm) 46.71 price in its cigarette portfolio by 16% (from INR270), as we roll forward Shares outstanding (m) 7,955 Major shareholder British American (31.2%) following the budget in March this our SOTP valuation components to year, but only saw sales volume fall FY15E (from FY14E), and now Financial summary (INR) by about 2% YoY for 1Q FY14 due to assign a target PER of 28x (formerly the new deluxe filter (DSFT) Year to 31 Mar 14E 15E 16E 25x) for its cigarette business. We Revenue (m) 365,127 425,625 495,477 cigarette segment, which made up believe the stock deserves to trade at Operating profit (m) 122,192 147,676 177,689 for the volume decline in the regular a higher PER as it is one of the few Net profit (m) 89,721 107,737 128,953 filter (RSFT) cigarette segment. Core EPS (fully-diluted) 11.278 13.543 16.210 consumer companies with good EPS change (%) 17.9 20.1 19.7 visibility on delivering consistently ITC recently raised prices by 3.2%, Daiwa vs Cons. EPS (%) 1.2 2.1 5.5 high-teen EBIT growth in the PER (x) 30.1 25.1 21.0 which we expect to have very little current uncertain environment, and Dividend yield (%) 1.8 2.2 2.6 impact on its sales volume. We thus reaffirm our Outperform (2) DPS 6.150 7.385 8.839 forecast it to raise prices by another PBR (x) 10.2 8.9 7.7 rating. The key risk to our call would EV/EBITDA (x) 20.1 16.6 13.7 2.6% on its , Scissors be lower-than-expected cigarette and Bristol brands in the coming ROE (%) 36.2 38.0 39.5 EBIT growth. Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 12 Consumer Staples / India ITC IN 17 October 2013

1 Buy How do we justify our view? 2 Outperform (unchanged)

3 Hold  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 Growth outlook  ITC: growth in sales and EPS (YoY) We forecast a sales CAGR for ITC of 16.2% for FY13-16, 25% and expect most segments to record relatively steady increases over the period. For the cigarette division, we 20% forecast a sales-volume decline of 1% YoY for FY14 and an average increase of 4% YoY for FY15-16. We forecast 15% an EPS CAGR of 19.2% over FY13-16, driven largely by 10% operating-profit margin expansion for the cigarette business. 5%

0% FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E Net sales growth EPS growth Source: Company, Daiwa forecasts

 Valuation  ITC: PER bands We use an SOTP methodology to value ITC. About 80% (INR) of our valuation comes from its cigarette business and 400 about 10% from its other FMCG business. The stock has 350 been rerated over the past three years along with many 300 of its domestic peers, as investors have assigned 250 increased multiples to the company’s defensive earnings 200 profile in India’s weak economic environment. 150 100 We now assign an FY15E PER of 28x (25x for FY14E 50 previously) to the cigarette business. We apply a 10% Jul-08 Jul-13 Apr-07 Oct-09 Apr-12 Jun-06 Jan-11 Jun-11 Mar-10 Feb-08 Feb-13 Nov-06 Sep-07 Dec-08 Aug-10 Nov-11 Sep-12 premium to our previous multiple due to the increased May-09 visibility we see and confidence we have in the company ITC Price (INR) 15x 21x 26x 32x to deliver high-teen EBIT growth over the next few Source: Company, Daiwa forecasts years.

 Earnings revisions  ITC: consensus EPS revisions The Bloomberg-consensus EPS forecasts for FY14 and (INR) FY15 have changed very little over the past 16 months. 14 Our EPS forecasts are higher than those of the 13 consensus by 1.2% for FY14, 2.1% for FY15 and 5.5% for 12 FY16, reflecting our expectations for lower sales-volume 11 decline in cigarettes for FY14 and higher cigarette EBIT growth. 10 9

8 Jul-12 Jul-13 Apr-12 Apr-13 Oct-12 Jun-12 Jan-13 Jun-13 Feb-13 Mar-13 Aug-12 Sep-12 Nov-12 Dec-12 Aug-13 Sep-13 May-12 May-13

Consensus EPS (INR) - FY14E Consensus EPS (INR) - FY15E Source: Bloomberg

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Financial summary

 Key assumptions Year to 31 Mar 2009 2010 2011 2012 2013 2014E 2015E 2016E Cigarettes volume growth (%) (2.5) 6.7 (2.8) 6.0 1.1 (1.0) 4.0 4.0 Cigarettes EBIT growth (YoY %) 16.3 18.0 17.5 19.8 20.9 18.2 19.8 20.2 FMCG others EBIT (INRm) (4,896) (3,803) (3,315) (2,151) (889) 656 1,929 3,697

 Profit and loss (INRm) Year to 31 Mar 2009 2010 2011 2012 2013 2014E 2015E 2016E Cigarette Revenues 80,755 97,964 111,309 129,543 147,384 166,432 194,891 228,824 Other FMCG Revenues 30,313 36,535 44,766 55,446 69,979 83,974 99,090 116,926 Other Revenue 54,494 56,860 69,672 80,265 98,913 114,721 131,644 149,727 Total Revenue 165,561 191,359 225,747 265,254 316,275 365,127 425,625 495,477 Other income 00000000 COGS (59,057) (69,870) (81,610) (96,442) (121,182) (140,946) (163,756) (189,830) SG&A (55,780) (58,248) (67,449) (76,715) (83,350) (92,442) (103,152) (115,781) Other op.expenses (5,809) (6,439) (6,991) (7,455) (8,591) (9,547) (11,041) (12,177) Operating profit 44,916 56,802 69,697 84,643 103,152 122,192 147,676 177,689 Net-interest inc./(exp.) (187) (648) (709) (805) (872) (848) (824) (800) Assoc/forex/extraord./others 5,119 6,303 5,361 7,844 8,776 9,628 10,425 11,367 Pre-tax profit 49,848 62,457 74,349 91,682 111,057 130,972 157,278 188,256 Tax (16,254) (20,349) (23,655) (28,458) (34,121) (40,239) (48,322) (57,839) Min. int./pref. div./others (348) (426) (515) (643) (855) (1,011) (1,219) (1,463) Net profit (reported) 33,246 41,682 50,179 62,581 76,081 89,721 107,737 128,953 Net profit (adjusted) 33,246 41,682 50,179 62,581 76,081 89,721 107,737 128,953 EPS (reported)(INR) 4.403 5.419 6.447 7.959 9.564 11.278 13.543 16.210 EPS (adjusted)(INR) 4.403 5.419 6.447 7.959 9.564 11.278 13.543 16.210 EPS (adjusted fully-diluted)(INR) 4.403 5.419 6.447 7.959 9.564 11.278 13.543 16.210 DPS (INR) 1.849 4.964 4.424 4.474 5.215 6.150 7.385 8.839 EBIT 44,916 56,802 69,697 84,643 103,152 122,192 147,676 177,689 EBITDA 50,724 63,241 76,688 92,098 111,743 131,739 158,717 189,865

 Cash flow (INRm) Year to 31 Mar 2009 2010 2011 2012 2013 2014E 2015E 2016E Profit before tax 49,848 62,457 74,349 91,682 111,057 130,972 157,278 188,256 Depreciation and amortisation 5,810 6,440 6,992 7,456 8,591 9,547 11,041 12,177 Tax paid (15,095) (20,744) (22,784) (24,153) (30,154) (40,239) (48,322) (57,839) Change in working capital (2,267) (848) 807 (5,726) (11,009) (5,170) (6,150) (7,038) Other operational CF items (3,312) (2,733) (4,276) (6,701) (7,467) (1,011) (1,219) (1,463) Cash flow from operations 34,985 44,573 55,087 62,557 71,018 94,099 112,628 134,091 Capex (17,609) (12,484) (14,982) (24,678) (26,443) (21,239) (22,964) (25,575) Net (acquisitions)/disposals 3,461 (21,734) 6,306 2,000 (420) (10,334) (12,401) (14,881) Other investing CF items 316 615 (37) (4,260) (11,951) 0 0 0 Cash flow from investing (13,831) (33,603) (8,713) (26,938) (38,814) (31,573) (35,365) (40,456) Change in debt (96) (810) (68) 169 (117) (25) (25) (25) Net share issues/(repurchases) 448 7,207 9,038 7,650 9,223000 Dividends paid (13,429) (14,487) (38,662) (35,026) (35,916) (48,922) (58,746) (70,314) Other financing CF items (2,388) (2,614) (6,105) (5,839) (6,290) 640 1,801 1,934 Cash flow from financing (15,466) (10,704) (35,797) (33,047) (33,100) (48,308) (56,970) (68,406) Forex effect/others 00000000 Change in cash 5,688 266 10,577 2,572 (895) 14,218 20,293 25,229 Free cash flow 17,376 32,089 40,105 37,878 44,576 72,860 89,664 108,517 Source: FactSet, Daiwa forecasts

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Financial summary continued …

 Balance sheet (INRm) As at 31 Mar 2009 2010 2011 2012 2013 2014E 2015E 2016E Cash & short-term investment 13,169 13,486 24,269 31,301 38,283 52,501 72,794 98,024 Inventory 47,943 50,920 57,348 64,269 75,221 87,509 101,695 117,915 Accounts receivable 8,036 10,093 10,867 12,002 13,958 16,124 18,808 21,908 Other current assets 15,959 15,526 17,356 17,162 23,987 23,987 23,987 23,987 Total current assets 85,108 90,025 109,840 124,734 151,449 180,121 217,284 261,834 Fixed assets 91,258 97,976 105,397 124,039 142,019 153,710 165,633 179,032 Goodwill & intangibles 0 0 000000 Other non-current assets 16,468 42,201 40,697 43,423 47,930 58,265 70,666 85,547 Total assets 192,833 230,202 255,934 292,195 341,398 392,096 453,583 526,413 Short-term debt 0 0 000000 Accounts payable 32,347 37,380 46,863 50,179 53,721 61,809 71,039 81,463 Other current liabilities 17,038 45,868 41,627 44,787 53,391 63,300 76,286 91,680 Total current liabilities 49,385 83,247 88,489 94,966 107,112 125,109 147,325 173,144 Long-term debt 1,867 1,108 1,138 1,073 908 883 858 833 Other non-current liabilities 0 0 000000 Total liabilities 51,252 84,355 89,627 96,039 108,020 125,992 148,183 173,977 Share capital 3,774 3,818 7,738 7,818 7,902 7,902 7,902 7,902 Reserves/R.E./others 136,507 140,765 157,161 186,767 223,677 256,151 295,145 341,818 Shareholders' equity 140,282 144,583 164,899 194,586 231,579 264,052 303,047 349,719 Minority interests 1,300 1,264 1,408 1,571 1,799 2,051 2,354 2,717 Total equity & liabilities 192,833 230,202 255,934 292,195 341,398 392,096 453,583 526,413 EV 2,693,158 2,692,046 2,681,438 2,674,503 2,667,584 2,653,593 2,633,578 2,608,686 Net debt/(cash) (11,303) (12,378) (23,131) (30,229) (37,375) (51,618) (71,936) (97,191) BVPS (INR) 18.578 18.796 21.187 24.746 29.111 33.193 38.094 43.961

 Key ratios (%) Year to 31 Mar 2009 2010 2011 2012 2013 2014E 2015E 2016E Sales (YoY) 12.9 15.6 18.0 17.5 19.2 15.4 16.6 16.4 EBITDA (YoY) 11.0 24.7 21.3 20.1 21.3 17.9 20.5 19.6 Operating profit (YoY) 9.7 26.5 22.7 21.4 21.9 18.5 20.9 20.3 Net profit (YoY) 5.3 25.4 20.4 24.7 21.6 17.9 20.1 19.7 Core EPS (fully-diluted) (YoY) 5.5 23.1 19.0 23.4 20.2 17.9 20.1 19.7 Gross-profit margin 64.3 63.5 63.8 63.6 61.7 61.4 61.5 61.7 EBITDA margin 30.6 33.0 34.0 34.7 35.3 36.1 37.3 38.3 Operating-profit margin 27.1 29.7 30.9 31.9 32.6 33.5 34.7 35.9 Net profit margin 20.1 21.8 22.2 23.6 24.1 24.6 25.3 26.0 ROAE 25.3 29.3 32.4 34.8 35.7 36.2 38.0 39.5 ROAA 18.2 19.7 20.6 22.8 24.0 24.5 25.5 26.3 ROCE 28.3 30.7 33.4 36.2 37.5 38.1 40.1 41.7 ROIC 24.7 28.6 33.8 37.5 38.8 40.2 44.6 49.2 Net debt to equity net cash net cash net cash net cash net cash net cash net cash net cash Effective tax rate 32.6 32.6 31.8 31.0 30.7 30.7 30.7 30.7 Accounts receivable (days) 18.6 17.3 16.9 15.7 15.0 15.0 15.0 15.0 Current ratio (x) 1.7 1.1 1.2 1.3 1.4 1.4 1.5 1.5 Net interest cover (x) 240.3 87.7 98.3 105.1 118.3 144.1 179.3 222.2 Net dividend payout 42.0 91.6 68.6 56.2 54.5 54.5 54.5 54.5 Free cash flow yield 0.6 1.2 1.5 1.4 1.6 2.7 3.3 4.0 Source: FactSet, Daiwa forecasts

 Company profile ITC is India’s largest cigarettes company, with a market share in value terms of than 80%. Its cigarettes portfolio includes strong brands such as , Navy Cut, Classic, Scissors, Bristol. Cigarettes account for 50-55% of its revenue and 80%+ of its EBIT. The other businesses ITC operates in are hotels, paperboards and packaging, agri business, lifestyle retailing, stationery, personal care and foods. It is currently investing largely in its non-cigarettes business, especially in personal care and food.

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 Cigarette price increases implemented by ITC Price hike Prev. price / New price / Wtd. avg. Brand Segment date stick (INR) stick (INR) Chg. price hike Gold Flake Regular Regulars Oct-12 4.50 4.80 6.7% 2.4% Sub-total 2.4% Gold Flake Kings Kings Mar-13 5.80 6.80 17.2% 1.8% Classic Kings Mar-13 5.80 6.80 17.2% 0.7% Remains resilient Wills Navy Cut Longs Mar-13 4.90 5.90 20.4% 1.1% Gold Flake Regular Regulars Mar-13 4.80 5.50 14.6% 4.7% Scissors Regulars Mar-13 3.50 3.90 11.4% 1.4% Bristol Regulars Mar-13 3.50 3.90 11.4% 1.0% Cigarette business still on a high Flake Regulars Mar-13 2.80 3.50 25.0% 3.1% Regulars Mar-13 2.80 3.50 25.0% 1.1% Cigarette price hikes demonstrate Other RSFT Regulars Mar-13 2.80 3.50 25.0% 1.0% Sub-total 15.9% company’s strong pricing power Gold Flake Regular Regulars Jul-13 5.50 5.80 5.5% 1.7% In addition to consecutive double-digit excise increases Gold Flake Kings Kings Aug-13 6.80 7.50 10.3% 1.1% Classic Kings Aug-13 6.80 7.50 10.3% 0.4% on cigarettes in the union budget (with one, of 21.5%, Sub-total 3.2% taking effect in March 2012 and another, of 18%, Source: Company, Daiwa implemented in March this year), and a VAT increase (375bps) on cigarettes in the states budgets this year, More cigarette price increases likely after ITC has raised its cigarette prices by 11.4-25% (as October 2013 shown in the following table). This demonstrates the company’s strong pricing power, in our view. As this October is the anniversary of the 2.4% price hike put that ITC had put through for its Gold Flake ITC raised the weighted average price of its cigarette Regular brand, we believe company is left with only a portfolio by 15.9% in March this year. This, together 19% YoY price hike for its entire cigarette portfolio with a 2.4% rise the company had put through for its during the rest of FY14. Gold Flake Regular brand in October 2012, led to a cumulative weighted average price increase of 18.3% While we believe a 19% price rise would suffice for ITC post the union budget. to increase the EBIT margin of its cigarette division by 110bps YoY for FY14 to 33.1% (vs. a 191bps YoY rise we Further, the company recently increased cigarette forecast previously) and this division’s EBIT by 18.2% prices in its premium Regular segment (ie, Gold Flake YoY for FY14 (higher than 17.6% YoY growth we Regulars), and its Kings segment, (ie, Gold Flake Kings forecast previously), based on the company’s cigarette and Classic brands), by a weighted average 3.2%. This price ladder for its different brands, we expect ITC to led to a weighted average cumulative price increase of raise its cigarette prices by a further weighted average 21.5% over August-September this year. However, we 2.6% in the coming months (as detailed in the believe the impact of the recent price rises in the Kings following table). This would lead to a cumulative and premium Regular segments will have little impact weighted average price increase of 21.7%. on ITC’s sales volume, as the company’s Gold Flake  ITC: estimated cigarette price increases in coming months Regular cigarettes, which were previously priced at Current price / Expected price / Wtd. avg. INR5.5/stick, were already retailing for INR6/stick Brand Segment stick (INR) stick (INR) Chg. price hike prior to the price hike, and the Kings segment is quite a Wills Navy Cut Longs 5.90 6.40 8.5% 0.5% price-inelastic segment. Scissors Regulars 3.90 4.30 10.3% 1.2% Bristol Regulars 3.90 4.30 10.3% 0.9% Total 2.6% Source: Daiwa estimates

We believe that if ITC raise prices as illustrated above, this would put pressure on the company’s sales volume but would help its cigarette EBIT to increase by 20% YoY for FY14. However, we only factor a 19% cigarette- price rise into our FY14 forecasts, as we estimate that this magnitude of price increase to be sufficient to bring about slight EBIT margin expansion and EBIT growth of 18.2% YoY for the cigarette division this fiscal year.

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Cigarette sales volume holding up despite This sales-volume deceleration from the premium sharp price hikes Regulars segment (69mm), ie, the Gold Flake Regular brand, was largely mitigated by the new DSFT segment The company’s Kings segment is still seeing sales- (64mm), with the company’s Gold Flake Super Star volume growth despite the sharp price increases. and Gold Flake Century brands that are priced from However, its premium Regulars segment, ie, the Gold INR2.8-3.0/stick. Some down-trading by consumers Flake Regular category (Gold Flake Premium and Gold was also seen from the popular Regular segment to Flake Filter brands), had faced some sales-volume brands in the DSFT segment, such as Capstan, Berkley, backlash after its price rose above the INR5/stick point Scissors, Duke, Flake, which are priced from INR1.9- in March this year. Nonetheless, our market research 2.5/stick. indicates that the deceleration in Gold Flake Regular’s sales volume has now stabilised.

 Gold Flake Kings (KSFT - 84mm), Gold Flake Premium (RSFT -  Gold Flake Kings (KSFT - 84mm), Gold Flake Premium (RSFT - 69mm) and Gold Flake Super Star (DSFT - 64mm) 69mm) and Gold Flake Super Star (DSFT - 64mm): illustration of size of filters

Source: Daiwa Source: Daiwa

We assume a 1% YoY sales-volume decline for ITC’s  ITC: cigarette division’s EBIT margin and EBIT growth cigarette division for FY14. The DSFT segment (64mm) 40% 22% 35% was exempted from any increase in excise duty in this 20% year’s budget, and we believe this segment will make 30% 18% up for a volume decline in the Regular segment. We 25% forecast the DSFT segment to account for about 6% of 20% 16% the company’s cigarette sales volume for FY14, 15% compared with almost zero a year ago. 14% 10% 12% Cigarette EBIT growth likely to be 5% 0% 10% maintained at a high-teen level FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E Despite the consecutive double-digit increases in taxes Cig. EBIT margin Cig. EBIT growth (RHS) over the past two years, for FY14 we now forecast ITC’s Source: Company, Daiwa forecasts cigarette division to increase its EBIT margin by 110bps YoY to 33.1% (formerly 34%) and its EBIT by 18.2% YoY on the back of a 19% YoY cigarette-price rise and cost-efficiency initiatives undertaken in the division.

Though the 18.2% YoY cigarette EBIT rise we forecast for FY14 is slightly lower than in recent years, we expect EBIT growth to improve over the subsequent two years, driven by the company achieving a fine balance between sales-volume growth and product price increases. For FY13-16, we forecast a cigarette EBIT CAGR of 19.4% for ITC.

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the product mix. We forecast a sales CAGR of 19% for Other FMCG division should this business for FY13-16. break even only at the end of  ITC: Other FMCG division’s EBIT FY14, despite new launches 6,000

We expect ITC’s Other FMCG division to continue to 4,000 launch new products and variants in new and existing 2,000 categories and believe this business will be a major sales-growth driver over the long term. The company 0 has declared its aim to enter most of India’s consumer -2,000 staples categories over the longer term and become one of the larger players in the country. -4,000 -6,000 Nonetheless, despite ITC’s new product launches and FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E continued investments in advertising and promotions Other FMCG EBIT (INRm) to build up its brands, we expect its Other FMCG Source: Company, Daiwa forecasts business to attain profitability for the first time only at the end of FY14. This is likely to be driven largely by increased profitability we project for its stationery and packaged foods business driven by an improvement in   ITC: new product launches Category Brand Quarter Description FY14 YTD Introduced four variants of soap with powerful skin nourishing ingredients, considered "food for the skin": Vivel with Green Tea, Vivel Aloe Vera, Vivel Soap Vivel 2Q Mixed fruit + Cream, Vivel Refresh + Moisturize. Deodorants Engage 1Q Introduced four variants: Rush (Male) & Blush (Female), Mate (Male) & Spell (Female), Urge (Male) & Tease (Female). Biscuits Sunfeast Delishus 1Q Introduced gourmet cookies in two flavours: 'Nut Biscotti' and 'Nut and Raisins'. Confectionery Candyman Jellicious 1Q Entered the jelly segment in confectionary The relaunch comprises new packaging and communication (in marketing), and the introduction of two new regional flavours: 'Apnu Mithu' and 'Masala Snack Foods Yumitos 1Q Jalsa' for the Gujarat market. Skin Care Vivel Cell Renew 1Q The range was expanded with the launch of a new variant of Body Lotion and 2 variants of Face Wash. FY13 Line of products comprising a Face Moisturiser, Hand Crème and Body Lotion: Vivel Cell Renew Fortify + Repair Face Moisturiser, Vivel Cell Renew Skin Care Vivel Cell Renew 4Q Fortify + Repair Body Lotion, Vivel Cell Renew Fortify + Repair Hand Crème. Soap 3Q Introduced India's First Gel Bar with 'Gold' in the signature series: Patchouli and Macadamia, Kiwi fruit and Green tea, Brazilian Orange and Ginseng. Confectionery Mint-o 3Q Launched 'mint-o Ultra mintz', a sugar-free extra-strong mint in select markets. Soap Fiama Di Wills 3Q Launched a 'Couture Spa' range of soaps under the 'Fiama Di Wills' brand. Soap Fiama Di Wills 3Q Launched a 'Collector’s Edition' soap series in association with the Lonely Planet Magazine under the Fiama Di Wills Men's range. Deodrants Fiama Di Wills 3Q Launched Fiama Di Wills Aqua Pulse deodorant in select markets. Soap Fiama Di Wills 2Q Launched a new variant , 'Exotic Dream' transparent gel bar, in select markets under the Fiama Di Wills brand. Biscuits Sunfeast 1Q Launched 'Kaju Badam Cookies' in select markets. Skin Care Vivel 1Q Launched 'Vivel Summer Fair', a differentiated summer-specific offering with Triple Filter SPF 15 and Aloe Vera for fresh, fair skin. FY12 Biscuits Sunfeast 4Q Launched Sunfeast Dark Fantasy Choco Fills and Sunfeast ‘Dual’ Dream Cream biscuits. Confectionery Mint-o 4Q Launched mint-o Gol Green and mint-o Strong. Snack Foods Tangles 4Q Launched a new product format, 'Tangles'. Snack Foods Mad Angles 4Q Launched a new innovative variant, ‘Mad Angles Masti Chaat’. Launched a Fiama Di Wills range of hair care treatment in three variants namely, ‘Anti Hair fall Control Shampoo with Conditioner and Serum’, ‘Colour Shampoo Fiama Di Wills 3Q Damage Control shampoo with Conditioner and Serum’ and ‘Total Damage Control shampoo with Conditioner’ which are enriched with rare natural oils and incorporate damage repair technology. Soap Vivel 3Q Launched ‘Vivel Clear 3 in 1’ soap which offers a threefold benefit by providing germ protection, moisturisation and nourishment. Biscuits Sunfeast 2Q Launched Sunfeast 'Dream Cream' split cream variants of 'Choco-Vanilla' and 'Strawberry-Vanilla' flavours. Snack Foods Bingo! Tangles 2Q Launched 'Bingo! Tangles' in an innovative product format in the finger snacks range. Confectionery Toffichoo 2Q Launched 'Lychee', a variant of 'Toffichoo'. Confectionery Mint-o 2Q Launched 'Lychee', a variant of 'mint-O Strong'. Launched ‘Fiama Di Wills Face and Body Talc’ in select markets. This product contains an ‘Enviro Defense Complex’ that protects the skin from sun damage Talc Fiama Di Wills 1Q and provides differentiated skincare benefits. It has been launched in three variants namely, ‘Swiss Soft’, ‘European Lite’ and ‘Australian Care in Sun’. Soap Fiama Di Wills 1Q Launched the Fiama Di Wills Aqua Pulse Bathing Bar exclusively for Men. Shower Gel Fiama Di Wills 1Q Launched the Fiama Di Wills Aqua Pulse Shower Gel exclusively for Men. Source: Company, Daiwa

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Net profit CAGR of 19.2% for FY13-16E We forecast ITC to record net profit growth of 18% YoY for FY14, driven largely by its cigarettes business. We forecast 18.2% YoY EBIT growth for its cigarette business this fiscal year, driven by price hikes. We Sales and earnings expect cigarette EBIT growth to improve going forward, on the back of cost efficiencies and product outlook price hikes. Finally, we expect its Other FMCG business to attain profitability from FY14 onwards.

Revisions to forecasts  ITC: net profit and net profit growth 140 30%

We present our forecasts for ITC for FY15-16 in this 120 25% report. Meanwhile, for FY14, we are making the 100 20% following changes to our sales and earnings numbers: 80 15% • We are increasing our FY14 revenue forecast by 5.1% 60 to incorporate the increase in cigarette prices on the 10% 40 back of the increase in taxes. 20 5% • We are revising up our FY14 net profit forecast by 0 0% 3.3%, which is a function of the higher sales we FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E expect for this fiscal year. Net profit (INRbn) Net profit growth (RHS) Source: Company, Daiwa forecasts Net sales CAGR of 16.2% for FY13-16E  ITC: sales and operating-profit forecasts by segment We forecast ITC to post net sales growth of 15.5% YoY Net sales (INRbn) FY14E chg. FY15E chg. FY16E chg. for FY14, and its cigarettes business to report a 1% YoY Cigarettes 166 12.9% 195 17.1% 229 17.4% sales-volume decline due to the steep price hikes put Other FMCG 84 20.0% 99 18.0% 117 18.0% through by the company during the year to offset the Hotels 13 10.0% 14 15.0% 16 12.0% increase in cigarette taxes. Agri business 86 20.0% 99 15.0% 114 15.0% Paperboards, paper etc. 47 12.0% 55 15.0% 61 12.0% Others 14 15.0% 16 15.0% 19 15.0% We forecast the company’s Other FMCG division to Inter-segment revenue 49 16.4% 57 15.1% 64 13.8% generate 20% YoY sales growth for FY14. This would Total 362 15.5% 422 16.6% 492 16.5% fall slightly short of its trajectory in recent years, as this Op. profit (INRbn) Cigarettes 102.8 18.2% 123.1 19.8% 147.9 20.2% business has grown its sales base substantially since its Other FMCG 0.7 n.m. 1.9 194.0% 3.7 91.7% inception, and thus we consider it prudent to assume Hotels 1.2 -18.6% 2.5 107.3% 3.2 27.3% more moderate sales growth going forward. Agri business 8.8 21.0% 10.0 13.6% 11.8 17.1% Paperboards, paper etc. 10.4 8.0% 12.3 17.8% 13.8 12.5% We forecast ITC’s sales growth to pick up in FY15 and Others 1.6 14.6% 1.8 14.8% 2.1 16.1% Unallocated exp/interest etc. 5.5 6.3% 5.6 2.3% 5.8 2.9% FY16, driven largely by the cigarette business. We project Total PBT 131 17.9% 157 20.1% 188 19.7% a net sales CAGR for the company of 16.2% for FY13-16. Net op-profit margin Cigarettes 61.7% 275 63.2% 141 64.6% 148  ITC: net sales and net sales growth Other FMCG 0.8% 205 1.9% 117 3.2% 122 Hotels 9.7% (341) 17.5% 779 19.9% 239 600 25% Agri business 10.2% 8 10.1% (13) 10.3% 19 Paperboards, paper etc. 21.9% (82) 22.5% 53 22.6% 10 500 20% Others 11.0% (4) 11.0% (1) 11.1% 11 400 Total 36.2% 74 37.3% 107 38.3% 103 15% Source: Company, Daiwa forecasts 300 10% 200

100 5%

0 0% FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E Net sales (INRbn) Net sales growth (RHS)

Source: Company, Daiwa forecasts

- 8 - Consumer Staples / India ITC IN 17 October 2013

 ITC: SOTP valuation Value per Basis Business FY15E multiples INR/share share (INR) EPS Cigarettes 28.0x 11.2 314 Hotels 20.0x 0.2 4 Agribusiness 10.0x 0.9 9 Paperboards 8.0x 1.1 9 Valuation and risks Sales FMCG - Others 3.0x 12.5 37 Cash Cash per share 19 Target price 392 Source: Daiwa forecasts Valuation  ITC: PER bands ITC remains our preferred pick in the India consumer (INR) space, as we believe the company will have the most 400 resilient earnings performance in the medium term 350 and that it will able to manage the excise increase on 300 cigarettes, with a fine balance between price increases 250 and sales volume. 200 150 We factor in a 1% decline in sales volume for FY14 for 100 its cigarettes business and expect the DSFT (64mm) 50 segment to help mitigate the volume decline. We Jul-13 Jul-08 Apr-12 Apr-07 Oct-09 Jan-11 Jun-11 Jun-06 Mar-10 Feb-13 Feb-08 Aug-10 Nov-11 Sep-12 Nov-06 Sep-07 Dec-08 forecast ITC’s cigarette EBIT to grow by 18.2% YoY and May-09 19.8% YoY for FY14-15. ITC Price (INR) 15x 21x 26x 32x Source: Company, Daiwa forecasts ITC has traded at an average PER of 24.6x over the past three years, 25.5x over the past two years, and 27.3x over the past year. The stock has witnessed a rerating over the past three years, along with many of Risks its domestic peers, as investors have assigned higher multiples to the company’s defensive earnings profile We have identified the following risks to our rating, in a weak economic environment. target price and forecasts for ITC, and attribute an equal weighting to the first three of these: We raise our six-month target price to INR392 (from • INR270), after rolling forward our SOTP valuation to Consumer demand for cigarettes dropping on the FY15E (from FY14E), and now assign a target PER for back of hefty price increases. the cigarette business of 28x (from 25x). We believe • ITC deciding to absorb part of the increase in the tax ITC deserves a higher PER given that it is one of the rate rather than pass it on to consumers. few consumer companies that provides strong visibility • and confidence in delivering consistent high-teen EBIT Cigarettes EBIT growth coming in lower than we growth in the current uncertain environment, unlike expected. most other companies in the consumer space. • The company’s FMCG business breaking even later than we expect. Cigarettes is one of the few businesses in the consumer space that is not affected by high crude-oil prices or increases in input costs, depreciation of the Rupee, and even for that matter any increase in competition. The only overhang on ITC would be a rise in government taxes, which have to be passed on, and would put pressure on company’s sales-volume growth. However even that event is still six months away, in our view. We maintain our Outperform (2) rating.

- 9 - Consumer Staples / India ITC IN 17 October 2013

Daiwa’s Asia Pacific Research Directory

HONG KONG SOUTH KOREA Hiroaki KATO (852) 2532 4121 [email protected] Chang H LEE (82) 2 787 9177 [email protected] Regional Research Head Head of Korea Research; Strategy; Banking John HETHERINGTON (852) 2773 8787 [email protected] Sung Yop CHUNG (82) 2 787 9157 [email protected] Daiwa’sRegional Deputy Asia Head Pacific of Asia Pacific Research Research Directory Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles; Rohan DALZIELL (852) 2848 4938 [email protected] Shipbuilding; Steel Regional Head of Product Management Jun Yong BANG (82) 2 787 9168 [email protected] Kevin LAI (852) 2848 4926 [email protected] Tyres; Chemicals Deputy Head of Regional Economics; Macro Economics (Regional) Mike OH (82) 2 787 9179 [email protected] Christie CHIEN (852) 2848 4482 [email protected] Capital Goods (Construction and Machinery) Macro Economics (Taiwan) Sang Hee PARK (82) 2 787 9165 [email protected] Jonas KAN (852) 2848 4439 [email protected] Consumer/Retail Head of Hong Kong Research; Head of Hong Kong and China Property Jae H LEE (82) 2 787 9173 [email protected] Jeff CHUNG (852) 2773 8783 [email protected] IT/Electronics (Tech Hardware and Memory Chips) Automobiles and Components (China) Joshua OH (82) 2 787 9176 [email protected] Grace WU (852) 2532 4383 [email protected] IT/Electronics (Handset Components) Head of Greater China FIG; Banking (Hong Kong, China) Thomas Y KWON (82) 2 787 9181 [email protected] Jerry YANG (852) 2773 8842 [email protected] Pan-Asia Head of Internet & Telecommunications; Software (Korea) – Internet/On-line Game Banking (Taiwan); Insurance (Taiwan and China) Leon QI (852) 2532 4381 [email protected] TAIWAN Banking (Hong Kong, China); Broker (China) Mark CHANG (886) 2 8758 6245 [email protected] CAO (852) 2848 4469 [email protected] Head of Research Capital Goods – Machinery (China) Steven TSENG (886) 2 8758 6252 [email protected] Eric CHEN (852) 2773 8702 [email protected] IT/Technology Hardware (PC Hardware) Pan-Asia/Regional Head of IT/Electronics; Semiconductor/IC Design (Regional) Christine WANG (886) 2 8758 6249 [email protected] Felix LAM (852) 2532 4341 [email protected] IT/Technology Hardware (Automation); Cement; Consumer Head of Materials (Hong Kong, China); Cement and Building Materials (China, Kylie HUANG (886) 2 8758 6248 [email protected] Taiwan); Property (China) IT/Technology Hardware (Handsets and Components) Dennis IP (852) 2848 4068 [email protected] Lynn CHENG (886) 2 8758 6253 [email protected] Power; Utilities; Renewables and Environment (Hong Kong/China) IT/Electronics (Semiconductor) John CHOI (852) 2773 8730 [email protected]

Regional Head of Small/Mid Cap; Small/Mid Cap (Regional); Internet (China) INDIA Joey CHEN (852) 2848 4483 [email protected] Punit SRIVASTAVA (91) 22 6622 1013 [email protected] Steel (China) Head of Research; Strategy; Banking/Finance Kelvin LAU (852) 2848 4467 [email protected] Navin MATTA (91) 22 6622 8411 [email protected] Head of Transportation (Hong Kong, China); Hong Kong and China Research Coordinator; Transportation (Regional) Automobiles and Components Jibo MA (852) 2848 4489 [email protected] Saurabh MEHTA (91) 22 6622 1009 [email protected] Head of Custom Products Group; Custom Products Group Capital Goods; Utilities Thomas HO (852) 2773 8716 [email protected] Mihir SHAH (91) 22 6622 1020 [email protected] Custom Products Group FMCG/Consumer Deepak PODDAR (91) 22 6622 1016 [email protected] PHILIPPINES Materials Norman H PENA (63) 2 813 7344 [email protected] Nirmal RAGHAVAN (91) 22 6622 1018 [email protected] ext 301 Oil and Gas; Utilities Banking/Property Michael David (63) 2 813 7344 [email protected] SINGAPORE MONTEMAYOR ext 293 Adrian LOH (65) 6499 6548 [email protected] Consumer/Retail Head of Singapore Research, Regional Head of Oil and Gas; Oil and Gas (ASEAN and China); Capital Goods (Singapore) David LUM (65) 6329 2102 [email protected] Property and REITs Ramakrishna MARUVADA (65) 6499 6543 [email protected] Head of ASEAN & India Telecommunications; Telecommunications (ASEAN & India)

- 10 - Consumer Staples / India ITC IN 17 October 2013

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- 11 - Consumer Staples / India ITC IN 17 October 2013

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- 12 - Consumer Staples / India ITC IN 17 October 2013

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DCMA Market Making For “DCMA Market Making” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

Research Analyst Conflicts For updates on “Research Analyst Conflicts” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The principal research analysts who prepared this report have no financial interest in securities of the issuers covered in the report, are not (nor are any members of their household) an officer, director or advisory board member of the issuer(s) covered in the report, and are not aware of any material relevant conflict of interest involving the analyst or DCMA, and did not receive any compensation from the issuer during the past 12 months except as noted: no exceptions.

Research Analyst Certification For updates on “Research Analyst Certification” and “Rating System” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The views about any and all of the subject securities and issuers expressed in this Research Report accurately reflect the personal views of the research analyst(s) primarily responsible for this report (or the views of the firm producing the report if no individual analysts[s] is named on the report); and no part of the compensation of such analyst(s) (or no part of the compensation of the firm if no individual analyst[s)] is named on the report) was, is, or will be directly or indirectly related to the specific recommendations or views contained in this Research Report.

The following explains the rating system in the report as compared to relevant local indices, based on the beliefs of the author of the report. "1": the security could outperform the local index by more than 15% over the next six months. "2": the security is expected to outperform the local index by 5-15% over the next six months. "3": the security is expected to perform within 5% of the local index (better or worse) over the next six months. "4": the security is expected to underperform the local index by 5-15% over the next six months. "5": the security could underperform the local index by more than 15% over the next six months.

Additional information may be available upon request.

Japan - additional notification items pursuant to Article 37 of the Financial Instruments and Exchange Law (This Notification is only applicable where report is distributed by Daiwa Securities Co. Ltd.)

If you decide to enter into a business arrangement with us based on the information described in materials presented along with this document, we ask you to pay close attention to the following items. • In addition to the purchase price of a financial instrument, we will collect a trading commission* for each transaction as agreed beforehand with you. Since commissions may be included in the purchase price or may not be charged for certain transactions, we recommend that you confirm the commission for each transaction. • In some cases, we may also charge a maximum of ¥ 2 million (including tax) per year as a standing proxy fee for our deposit of your securities, if you are a non-resident of Japan. • For derivative and margin transactions etc., we may require collateral or margin requirements in accordance with an agreement made beforehand with you. Ordinarily in such cases, the amount of the transaction will be in excess of the required collateral or margin requirements. • There is a risk that you will incur losses on your transactions due to changes in the market price of financial instruments based on fluctuations in interest rates, exchange rates, stock prices, real estate prices, commodity prices, and others. In addition, depending on the content of the transaction, the loss could exceed the amount of the collateral or margin requirements. • There may be a difference between bid price etc. and ask price etc. of OTC derivatives handled by us. • Before engaging in any trading, please thoroughly confirm accounting and tax treatments regarding your trading in financial instruments with such experts as certified public accountants. *The amount of the trading commission cannot be stated here in advance because it will be determined between our company and you based on current market conditions and the content of each transaction etc.

When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us.

Corporate Name: Daiwa Securities Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.108 Memberships: Japan Securities Dealers Association, Financial Futures Association of Japan Japan Securities Investment Advisers Association Type II Financial Instruments Firms Association

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