ITC's cigarette volume growth hits margins in Q4; stock falls 2.6%

Net profit growth of 19 per cent was ahead of estimates led by higher other income

Even as ITC posted higher-than-expected top line and net profit figures for the March 2019 quarter (Q4), investors were disappointed due to lower profitability. The ITC stock shed 2.6 per cent to close at Rs 289.85 in a weak market (the S&P BSE Sensex was down about 1 per cent).

While ITC’s top line grew by 13.1 per cent year-on-year to Rs 11,850 crore in Q4, its net profit was up 18.7 per cent to Rs 3,482 crore, ahead of Bloomberg consensus estimates of Rs 11,822 crore and Rs 3,242 crore, respectively. What hurt investors, despite a strong 8 per cent rise in cigarette volumes and 3 per cent price hikes, was the miss on the Ebitda (earnings before interest, tax, depreciation and amortisation) margin. The Ebitda margin contracted by 102 basis points year-on-year to 38.1 per cent, lower than the Street’s expectations of around 39 per cent.

With 84-85 per cent operating profit contribution, a 73 basis point fall in cigarette’s Ebit (earnings before interest and tax) margin weighed on overall profitability. Q4 was the second consecutive quarter of Ebit margin decline in the cigarettes segment. The higher share of low-margin cigarettes dragged the segment’s margin in Q4. In order to protect overall cigarette volumes from price hikes, ITC launched new variants at a lower price and the price hikes were also lower than the increase in input costs of cigarettes (around 14 per cent). Given the business’s contribution to ITC’s overall profits, driving its profitability should now be the priority going ahead, say analysts.

“Since cigarette volume growth is back to normalcy in high-single digit in the last two quarters and tax overhang still persisting, ITC should focus on profitability by taking price hikes in national brands. This should not hurt cigarette volumes materially as the business is gradually coming back to price inelasticity,” says Nitin Gupta analyst at SBICAP Securities.

Slower consumption demand could be another pain, impacting other-FMCG businesses such as packaged foods, which grew by just 7.3 per cent year-on-year in Q4.

Among the few silver linings, average room rate and occupancy level in the hotels business are improving and should support overall margin to some extent. This business, too, has reported a 110 basis point year-on-year decline in the Ebit margin in Q4.

On the whole, net profit growth was also driven by 43.3 per cent year-on-year jump in other income at Rs 740 crore.

Thus, investors are recommended to wait until some signs of margin improvement emerge.