ITC: Pricing gains offset cigarettes volume decline

Analysts expect volume pressure to continue; profit growth likely to be intact

ITC's cigarettes business continued to post strong margin gains in the second quarter of FY15, excluding one-offs. Despite an estimated fall of 4-5 per cent in cigarettes volumes, strong pricing power led to a 14 per cent year-on-year (y-o-y) growth in cigarettes sales to Rs 4,251 crore in the July-September 2014 quarter. And this trend of healthy rise in profits amid volume growth pressure is likely to continue through this financial year.

Suruchi Jain, equity research analyst at Morningstar India, says: "We expect flattish to negative cigarettes volume growth in FY15."

Although the Street was expecting ITC's fast-moving consumer goods (FMCG) business to post operating profit of Rs 20-30 crore in the September quarter, this segment reported a loss of Rs 10-crore. While this was lower than the year-ago period's loss of Rs 13 crore and the June 2014 quarter's loss of Rs 15.6 crore, it triggered some disappointment as there were expectations of this business turning around in FY15.

"We expect the FMCG segment to post losses this fiscal (FY15). Our key concern is that ITC is investing its cigarettes profits into other businesses rather than giving it back to its shareholders. We believe the company is better off hiving off or selling its hotels business," says Jain.

Overall, ITC results were largely in line with the Street's expectations. On a y-o-y basis, sales at Rs 8,930 crore were up 14.8 per cent, while net profit grew 8.7 per cent to Rs 2,425 crore, versus consensus Bloomberg expectations of Rs 9,018 crore of sales and Rs 2,430 crore of net profit. At 39.1 per cent, ITC's earnings before interest, taxes, depreciation, and amortisation (Ebitda) margin was slightly better than consensus expectations of 38.6 per cent, though it contracted 178 basis points on a y-o-y basis. Net profit and Ebitda margin were impacted by one-offs in the year-ago quarter. ITC had written back excess provisions towards tax and interest costs worth Rs 193 crore in the September 2013 quarter. Adjusting for this write-off, net profit grew by a healthy 15.6 per cent and was aided by a 44.7 per cent rise in other income. Not surprisingly, ITC's stock initially fell sharply citing the lower reported profit growth. From intra-day highs of Rs 360, it fell to Rs 352 levels.

Among other businesses, barring hotels, revenue growth remained healthy. Hotels' profitability was impacted by higher depreciation of Rs 13 crore on fixed assets. Consequently, the segment slipped into losses (Rs 10 crore) this quarter. Adjusting for one-offs, cigarettes Ebit (earnings before interest and taxes) margins expanded 300 basis points to 67.8 per cent.

Healthy traction in wheat, soya and coffee fuelled agri revenues, though margins contracted 157 basis points to 14.5 per cent. Paper business's margins were flattish due to higher input cost inflation. ITC's packaged foods business grew faster than industry in the quarter driven by launches of new variants in Bingo, Aashirvaad, Sunfeast Mom's Magic, among others. Personal care products (Engage, Fiama Di Wills, etc) grew well, too.

The stock, which closed at Rs 355.25 a share on the BSE on Friday, trades at 24 times FY16 estimated earnings and appears fairly valued for now.