ITC: Consistent FMCG profits must for re-rating

This and higher segment revenues will aid in diversification and a re-rating, as will in cigarette volumes

The ITC scrip had always traded at a valuation discount of 10-15 per cent to Hindustan Unilever (HUL). The gap has widened in the past year to 40 per cent, due to weakness in cigarette volumes. At Tuesday's closing price of Rs 329, the ITC scrip trades at inexpensive valuations of 25.7 times the FY16 estimated earnings.

ITC's focus on growing its non-cigarette FMCG (FMCG) business could lead to a re-rating of the scrip over the next two to three years, believe analysts. However, delivery of sustainable profits in the FMCG business is a pre-requisite.

Vivek Veda, consumer analyst at Societe Generale, says: “The FMCG business has not delivered consistent profits and its cash cow business of cigarettes is under huge pressure. Thus, consistent profitability of the FMCG business is key for re-rating.”

At the annual general meeting last week, Chairman Y C Deveshwar emphasised the focus on growing the FMCG business. At Rs 9,044 crore in FY15, the segment's revenue is a fifth of the total; the idea is to raise the figure to Rs 1,00,000 crore by 2030. With the high competition in the sector, is this achievable? Some say it is ambitious and others that ITC will need to step up acquisitions to do so. As this target requires compounded annual growth of 26-27 per cent, ITC will need aggressive launches and to spend on advertising. Overall, it will have to invest continuously in this business to reach the target.

The packaged foods segment comprises brands such as Aashirvaad, Sunfeast, Bingo!, Yippee!, Kitchens of India, mint-o and B Natural, among others, and has been performing well. Personal care products under the brands ‘Essenza Di Wills’, ‘Fiama Di Wills’, ‘Engage’ and ‘Vivel’, among others, have lagged. Analysts believe it will take another two to three years for this segment's profitability to stabilise, subject to ITC's investments.



ITC has been present in FMCG for over a decade but has not seen decent profit. It had seen full-year earnings before interest and taxes in FY14 and FY15 worth Rs 12 crore and Rs 31 crore, respectively; these profits have been lumpy on a quarterly basis. This is because the company continues to invest in new launches and advertising across sub-categories.

Suruchi Jain, consumer analyst at Morningstar, says: "We are not comfortable with the fact that ITC is continuing to launch new products without focusing on profits." She expects profitability to improve as economies of scale start kicking in.

ITC's ability to invest in FMCG is also dependent on healthy cash generation in cigarettes. This segment has seen falling volumes over the past few quarters on increasingly stringent regulations and higher taxes. However, assuming no further regulatory action, analysts believe improvement in cigarette volumes is another two to three quarters away. A rise in cigarette volumes will be another key catalyst for the stock.

Analysts remain positive on ITC's dairy foray, as the segment has so many unorganised entities and the company's strong rural franchise will aid growth of this segment.