Result Update October 28, 2016 Rating matrix Rating : Buy ITC Ltd (ITC) | 243 Target : | 277 Target Period : 12 months Potential Upside : 14% Cigarette 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 cigarettes 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 Aashirvaad & 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 India 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 ICICI Securities Ltd | Retail Equity Research Page 2 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.