ITC: Improved show by cigarettes business

Cigarette volumes up; full impact of price hikes yet to play out; other non-FMCG segments a drag

An increase in cigarette volumes after nearly 12 quarters of a decline is the key highlight in ITC’s results for the June quarter (Q1).

While the company does not share volume figures and the Street was estimating it to increase by one to two per cent in Q1, Abneesh Roy of Edelweiss Securities estimates ITC’s cigarette volume to have grown by three to four per cent.

Though volumes look higher, given the low base of the year-ago quarter where volumes fell 17 per cent, they top expectations. This, along with healthy growth in FMCG (fast-moving consumer goods) business led to a 9.8 per cent year-on-year growth in revenues (net of excise) to Rs 10,054 crore, ahead of Bloomberg consensus estimate of Rs 9,383 crore.

Limited gains in margins of cigarette segment (up 54 basis points to 36.5 per cent) and fall in margins of other segments hit net profit growth. This measure grew 10.1 per cent to Rs 2,385 crore in Q1 and missed Bloomberg consensus estimate of Rs 2,485 crore. But for higher other income, net profit would have been even lower. Other income jumped 18 per cent year-on-year in Q1 to Rs 421 crore.

FMCG sales (excluding cigarettes) grew at a healthy 9.5 per cent, even as they reduced operating losses to Rs 5 crore from Rs 8 crore a year ago. Part of the profit improvement was driven by lower promotional expenses as reflected in the other expenses. Hotels’ business continued to be under pressure amid a weak demand and pricing scenario. Paper business, too, witnessed headwinds on account of slow demand in user sectors (FMCG and cigarettes). Though agriculture business saw healthy revenue growth due to good traction in domestic sales and leaf tobacco exports, profit margins remained weak in Q1.

While for now the tax increases on cigarettes (both state and central) have been lower than expected, analysts are watching out for ITC to fully pass the higher taxes. The actual quantum of price hikes will be key in determining growth (or fall) of cigarette volumes in FY17. ITC seems to have been going slow in taking price hikes. The nominal increase in cigarette margins in Q1 seems to suggest price hikes in Q1 have been limited. Also, regulatory risk on ITC’s cigarette business is far from over.

Implementation of goods and services tax (unified sales tax) will be a key risk for cigarette makers, as a tax rate of 40 per cent is proposed, much higher than the 25 per cent value-added tax now. But, most analysts are positive on ITC, given the lower valuations.