ITC: Strong operating performance surprises

Cigarette price hikes spur profits but volumes might remain under pressure

The ITC scrip rallied four per cent to Rs 316 on Thursday, despite it missing Street expectations on revenues and net profit for the June quarter. The stock has been an under-performer in the past five-six months, so some improvement in sentiments would have played out. But, more importantly, strong operational performance across segments explains the rally.

Improving profitability of cigarette business (85 per cent of overall earnings before interest and tax or Ebit) eclipsed the weakness in revenues. Ebit margins in both cigarettes and agri expanded 223 basis points (bps) and 391 bps to 67 per cent and 10.1 per cent, respectively. Continued price hikes in the cigarettes business, aimed to pass on higher taxes, was the key driver of this segment's profitability and more than offset the volume decline. Losses in the non-cigarette FMCG business also fell 49 per cent to Rs 8 crore, though some brokerages like MOSL were expecting a positive Ebit of Rs 15 crore. Notably, despite consistent revenue growth, this business has witnessed volatility in its profitability.

Except for the paper segment, all other ones posted improvement in profitability. Aided by lower input costs, ITC’s overall Ebitda margin thus grew 404 basis points to 39.8 per cent in the quarter.

Nitin Mathur of Societe Generale was enthused by the strong margin expansion on the back of cigarette price hikes and benign input costs. He has a strong ‘buy’ on the stock given relatively cheaper valuations.

Higher other income further aided net profit, which grew 3.6 per cent year-on-year to Rs 2,265 crore but was still marginally short of estimate of Rs 2,322 crore.


On the flip side, revenues in most segments barring FMCG and hotels fell. Net sales, thus, were lower by 7.2 per cent year-on-year at Rs 8,506 crore, nine per cent below estimate of Rs 9,349 crore. This is ITC’s first sales decline since the March 2009 quarter when it contracted 1.1 per cent year-on-year.

While cigarettes business (two-fifths of revenue) was impacted by an estimated volume fall of 17-18 per cent, lack of export opportunities in wheat and soya pulled down agri revenues (a fourth of revenues). Revenues of paper business (12 per cent) too fell on account of lower demand and higher competition from cheaper Chinese imports. Positively, hotels revenues was partly boosted by low base in the June 2014 quarter (impacted by weak economy, elections), increase in occupancy rates and opening of new properties. Revival in economic activity is a pre-requisite to sustained revenue momentum in this segment which analysts believe will remain muted in the near-term.



Analysts like Abneesh Roy of Edelweiss believe ITC will continue to face challenges in the next two quarters and hence is reducing full-year sales estimates for the company. He expects cigarette volumes to witness double-digit fall in Q2 as well. Nevertheless and even as lack of near-term triggers may limit upsides, most analysts remain bullish on ITC due to inexpensive valuations of 23 times FY16 estimated earnings.