Core business visibility improves

FMCG giant ITC has recently been in the news following the government decision to not impose new pictorial warnings on cigarette packs. Analysts believe this development is positive for the company and expect a good upside in the stock from the current level.

Some relief
The government on December 7 retained the existing pictorial warnings on cigarette and bidi packages for a year. The health and family welfare ministry had notified to replace the existing pictorial warnings (scorpion on bidi packs and cancer-affected lungs on cigarettes) with more stern warnings (of a cancer-afflicted mouth) from December 1.

This decision is being seen in a positive light given that it would have been a difficult task for cigarette makers to call back stock lying with retailers or repackage inventories. An unfavourable ruling would have led to losses for the cigarette manufacturers.
 

ON STRONG TURF
In Rs crore	FY10	FY11E	FY12E
Sales	18,298	21,819	24,982
EBITDA (%)	33.70	33.60	34.20
Net profit	4,009	4,807	5,618
P/E (x)	15.70	26.40	22.30
E: Estimates                                                               Source: Bloomberg

In addition, the cigarette makers would have had to shell out higher printing and packaging costs for the new warnings.

While major cigarette makers had stopped the production of cigarettes (since December 1), this move would have had no impact on their top line as they had stock for 25-30 days. After this decision, the major players are expected to resume production soon.

Business growth intact
ITC is the leader in the tobacco industry, with a market share of 80 per cent. ITC’s near monopolistic position and deep customer understanding has enabled it to manage surging taxes in recent years (through a combination of judicious price increases and improvements in the product mix) and has also keep the competition at bay.

Analysts point out that though leading foreign brands have been present in the country, they haven’t been able to dent ITC’s position. Of late, Godfrey Phillips India has witnessed a limited off-take for its new product, Marlboro Gold Advance Compact, which was launched recently. Analysts do not see this new product as a major threat to ITC’s volumes. Broadly, they expect 12-13 per cent revenue and 15 per cent Ebit CAGR for the cigarette business over FY10-FY13.

The cigarette business contributes half of ITC’s top line and over three-fourths of its profits. The free cash flows in this business should further aid ITC’s plans in its emerging and other businesses.

The road ahead
ITC also has a visible presence in hotels, agri-products and non-cigarette fast moving consumer goods like personal products, packaged foods and apparel. Many of these have promising prospects. While its hotel business is likely to show a strong cyclical recovery with Ebit doubling over FY10-FY12, analysts believe the losses in its fast growing non-cigarette FMCG will decline to Rs 50-60-crore per quarter, with a break-even likely next financial year.

Key triggers for ITC include higher than anticipated cigarette volume growth, a pick-up in tourism, which would improve hotel room rates and occupancy, and a sharper fall in losses in non-cigarette

FMCG businesses. Analysts are bullish on the stock at the current level of Rs 167, where the PE works out to be 22.3 based on estimated 2011-12 earnings.