ITC: Valuations attractive despite regulatory risk

FMCG business growth ahead of sector; analysts expect Ebit to grow in early teens in FY16

Frontline consumer stocks took a beating on Monday as the market fears the sector’s top line growth would suffer due to a slowing in rural demand. The market is justifiably worried about the sector’s growth in the face of stretched valuations. ITC is the cheapest stock in the pack and given the weak earnings outlook for the broader markets, interest is reviving in the stock of late, despite a punitive taxation regime. Most consumer stocks are trading at a earnings multiple of 45-57 times for FY16. The largest fast-moving consumer goods company (FMCG), Hindustan Unilever, is trading at 43.6 times its FY16 earnings, while ITC is trading at 26 times.

While cigarette volumes are expected to take a hit in the March quarter, as well as the new financial year, ITC’s FMCG business is expected to grow at a robust pace. Cigarette volumes are expected to decline 15 per cent, much worse than in the December quarter. The average 13-14 per cent increase in prices would have had an impact on volumes. Antique Stock Broking expects the company’s FMCG segment to post a profit of Rs 56 crore in the March quarter.

The management has conveyed to analysts that despite the fall in cigarette volumes, the earnings trajectory would be maintained in the early teens in FY16. ITC’s earnings before interest and taxes (Ebit) growth over the first nine months of FY15 has remained stable at 14.1 per cent, even as volumes declined in double digit in the December quarter. HDFC Securities says the management is confident of low teen Ebit growth in FY16, which the brokerage thinks is achievable. ITC expects rationality to emerge in excise rise from the next Budget. Analysts expect Ebit to grow at a compound 15 per cent annual growth rate over FY15-17.

In addition, the FMCG business is growing ahead of the sector. Foods account for 70 per cent of ITC’s FMCG business and that category has seen volume growth better than of rivals. The company has also emerged the second largest player in the deodorant market within a year of launch. Analysts believe the firm’s entry into new categories such as chocolates, dairy and juices will add to growth in the segment. Analysts expect the FMCG business to cross Rs 10,000 crore in sales in FY16.