Cigarettes continue to drive ITC's profitability

While hotels and FMCG saw weak top line growth, most segments witnessed Ebit margin contraction

Strong performance by the cigarette business came as a surprise, but could not fully offset the impact of weaker margins for ITC in the June quarter. Sales were up 24.9 per cent year-on-year (y-o-y) to Rs 9,164 crore - ahead of Bloomberg consensus estimates of Rs 8,465 crore - but the earnings before interest, taxes, depreciation, and amortisation (Ebitda) margin fell 223 basis points to 35.4 per cent, short of expectations of 37.5-38.1 per cent. Consequently, and partly due to higher tax rate, ITC’s net profit - though up 15.6 per cent to Rs 2,186 crore - came in a tad below expectations of Rs 2,217 crore.

The cigarette business’ revenues grew 18.8 per cent y-o-y to Rs 4,201 crore and Ebit (earnings before interest and tax) margin was up 142 basis points to 64.8 per cent, largely driven by price rises.  Thus, its ebit jumped 21.4 per cent at Rs 2,722 crore. Abneesh Roy, associate director - institutional equities - research, Edelweiss Securities, says cigarette volumes have fallen by three per cent, y-o-y. While ITC might further raise cigarette prices in FY15 in view of the duty increase, the actual impact on volumes will depend on its strategy in the 64-mm segment, which has seen a duty hike of 72 per cent. However, given ITC’s track record, analysts expect a healthy profitable growth in this business.

The key disappointment came from the fast-moving consumer goods (FMCG) business, which reported a Rs 16-crore loss at Ebit level. Although the loss was lower than Rs 19 crore in the year-ago period, analysts were expecting a profit of Rs 20-25 crore. Part of this can be attributed to muted revenue (Rs 1,935 crore) growth of 10.9 per cent, the lowest in the past 10 quarters. ITC’s FMCG revenue growth has come off from 23-30 per cent quarterly run-rate witnessed between December 2011 and March 2013 to 13-18 per cent in FY14. However, it might  not be correct to blame ITC alone. The overall demand environment remains weak, something its larger peer HUL also stated on Monday. Since a large part of its products are in slowing discretionary categories, ITC has felt the heat.

Hotels, too, continued to be under pressure due to weak macro and election (more dry days). On flattish sales of Rs 249 crore, it posted a loss of Rs 12.1 crore at Ebit level (versus Rs 9 crore profit in the year-ago period) impacted by an additional depreciation of Rs 14.3 crore due to revision in useful life of assets.  Although agri revenues grew 51 per cent to Rs 3,296 crore  aiding top line growth, it put pressure on the overall margins - segment margins were down 300 basis points due to cost inflation. Paperboards grew at a healthy pace of 10 per cent, but margins fell 30 basis points.   At Rs 357, the ITC scrip trades at 27.7 times FY15 estimated earnings, a premium over its five-year average of 24 times. Most analysts remain positive on ITC with the average target price being Rs 391. However, expect some knee-jerk reaction on the stock on Wednesday, given the results and the 10 per cent gains in the past month.