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ITC: Rise in excise duty may prove an overhang
January, 27th 2012

Even as volumes show signs of slowing, company clocks robust revenue growth across FMCG categories.

Indias largest cigarette maker, ITC, has proved yet again it can deliver on both revenues and earnings, even in a difficult environment. Despite talk of an imminent slowdown in the consumer segment, the company has seen healthy revenue growth across divisions. Revenues grew 14.2 per cent to Rs 6,195 crore in the December quarter, driven largely by the non-cigarette fast-moving consumer goods (FMCG) segment, cigarette and the agri-businesses.

With the cigarettes segment contributing around 75 per cent to the operating profit, the performance of this business is key. In the December quarter, the companys earnings before interest and taxes (Ebit) margins improved 176 basis points to 57 per cent, on the back of the numerous price increases it undertook through the year.
According to Morgan Stanley analysts Nillai Shah, Sanath Sudarsan and Girish Achhipalia, ITCs third quarter results are ahead of estimates. However, we expect the stock to correct on the back of this result, given the sluggish cigarette volume growth of 4.5 per cent, as against the seven per cent growth expected by us and the market.

ITCs volume growth has been lower than competitors. A price increase of six per cent in this financial year resulted in a mere five per cent cigarette volume growth in the third quarter, lower than the market as well as VST Industries (the third-largest cigarettes manufacturer), which reported about 12 per cent growth, says Nitin Mathur, analyst at Espirito Santo Securities.

According to analysts, the companys non-cigarette FMCG business has seen robust growth in the December quarter. Revenue for other FMCG businesses grew 24 per cent y-o-y to Rs 1,370 crore. The other positive is that Ebit losses for the FMCG business have also fallen to Rs 46.6 crore from Rs 55 crore in the second quarter. Says Mehul Desai, research analyst at KR Choksey: This indicates losses are coming down and the FMCG business will turn Ebit positive by FY13.

The company clocked robust growth across the packaged foods and personal care categories. However, the hotel business continued to be impacted by the weak economic environment. Despite this, it saw margins improve by 504 basis points year-on-year.

On the downside, analysts are expecting the Centre to raise the excise duty by 10-15 per cent. However, an increase of 20 per cent would prove to be negative for the company. The stock is currently trading at a price/earnings multiple of 23 times FY13 earnings. Most analysts believe there is more upside in the stock, given that most other FMCG stocks are trading at significantly higher multiples.

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