Sustained growth in these three segments will drive ITC stock's re-rating

Good print across segments and consistency in execution can drive re-rating of ITC from current levels, highlighted Kotak Institutional Equities

Analysts are finally turning optimistic about tobacco to FMCG conglomerate ITC as the company’s growth trajectory appears to be stabilizing. 
 

While some brokerages have moderately revised their target prices on the stock post December quarter (Q3FY22) results, consensus view backs a re-rating in the stock going-forward.
 

The company, on Thursday, reported 15 per cent year-on-year (YoY) rise in consolidated net profit at Rs 4,056 crore for the quarter ending December 31, 2021, while consolidated revenue from operations rose 30 per cent YoY to Rs 18,366 crore.
 

Segment-wise, revenue in cigarettes/FMCG/hotels/agri/paper segments grew 14/9/101/100/39 per cent YoY, respectively.

"Given the strong Q3 performance and positive demand environment, we raise our EPS estimates for FY22/23/24 by 1/1/1 per cent. Muted performance of other FMCG companies will be a key for ITC's re-rating," said analysts at HDFC Securities.
 

The highlight of the quarter was a solid recovery in three key segments – Cigarettes, FMCG, and Hotels – which, analysts say, will drive the stock's momentum in quarters ahead.
 

"The cigarettes business posted a much stronger-than-expected growth in volumes (likely around 12 per cent vs expectations of 8 per cent) which has now surpassed the pre-pandemic run-rate. Improved volumes helped the business deliver a strong 14.4 per cent growth in cigarettes EBIT helped by 50bps expansion in margin. Double-digit EBIT growth in cigarettes is an important driver of stock momentum," said analysts at JM Financials.
 

As regards FMCG, Covid-gainer categories (hygiene, staples, and convenience foods) continue to track ahead of pre-Covid-19 levels. Urban markets benefited from lifting of restrictions while in rural markets, ITC outperformed the industry.
 

FMCG EBIT margin stood at 5.9 per cent, down 50 bps YoY and 80 bps QoQ. EBITDA margin stood at 9.1 per cent in Q3FY22 (versus 7.7 per cent in Q3FY20) despite the unprecedented commodity inflation, largely offset through strategic cost savings, product mix, pricing actions, fiscal incentives, and favorable business mix. This K-shaped growth in FMCG is expected to be sustained, said CLSA in its report. 

Lastly, the hotels segment continued to recover well with revenues rising 2x to Rs 470 crore and up 61 per cent on a sequential basis. This, however, is still lower by 14 per cent compared to Q3FY20 high. EBIT for hotel business turned green for the first time after the Covid impact with a profit of Rs 50.6 crore compared to a loss of Rs 67.3 crore in Q3FY21. 

"Several cost initiative measures introduced to strengthen the performance and offset the impact of negative operating leverage should help going forward," said a report by ICICI Securities.
 

An overall good print across segments and consistency in execution can drive re-rating from current levels, highlighted Kotak Institutional Equities.

On a holistic level, Edelweiss Securities has upgraded the stock to ‘Buy’ with a revised target price of Rs 285 from Rs 265 given no tax hike for second consecutive year in the Union Budget, correction of the stock by 11 per cent from its peak levels, 4.5-5 per cent dividend yield, reduced abatement in chewing tobacco making them pricier and benefitting cigarettes, and overall limited downside.

ICICI Securities, too, expects ITC's stock to benefit from expectation of Value (on current FCF profile basis) to outperform Growth/Expensive basket, potential price hikes in cigarettes in the current inflationary environment, good underlying performance in the FMCG business along with higher profit, and improving outlook for the hotels business (likely cyclical upturn). 
 

That said, Motilal Oswal Financial Services believes a high base and increasing commodity cost pressures are likely to affect EBIT growth in FMCG - Others over the next few quarters, further delaying a reduction in its dependence on the Cigarette segment to grow overall earnings at a healthy pace.

On the bourses, the stock of ITC gained 1.7 per cent intra-day to hit a high of Rs 238.5 on Friday. Over the past two weeks, the stock of the company has rallied 8 per cent on the BSE as against a 0.4 per cent decline in the S&P BSE Sensex. 

Source: Brokerage Reports