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A puzzle for value hunters…
ITC’s 1Q performance was soft vs. its FY19 show but in-line with FMCG peers. We expect 1Q growth trajectory to replicate over FY20, led by higher base of cig. volume growth and consumption slowdown. We value ITC on SoTP basis (link to table) and arrive at a TP of Rs 362 (implied P/E of 28x vs. earlier assigned P/E of 32x). We de-rate cigarette business by 10% (EV/EBITDA 18x vs. 20x implied earlier) owing to slower than expected volume growth in the era of stable taxes. Maintain BUY.
HIGHLIGHTS OF THE QUARTER
* Cig. revenue growth missed estimates with value/volume growth of 6/3.5% (10/5.5% in FY19) vs. exp. of 9/5.5%. 5th consecutive quarter of volume growth vs. -4% CAGR over FY12-18. A high base and slowdown impacted volume growth in 1Q.
* Cig. EBIT grew by 8% (6.5% CAGR over FY15-19) vs. exp. of 9% growth. Cig. EBIT margins expanded by 145bps owing to
(1) Price hikes (~3%) and
(2) Scaling manufacturing of capsules (70% in-house by Dec-19). Margin decline in FY19 was the key concern on the street, we expect this to reverse in FY20. We expect cig EBIT CAGR of 8% over FY19-22E.
* Non-cig business grew by 12% (exp. 11%). FMCG biz growth of 8% was in-line vs. its peers (HUL/Dabur/Marico/Colgate 7/11/6/6%). FMCG EBITDAM expanded by 140bps to 5.9%.
* Hotels/Agri/Paper revenue grew by 15/15/13% with EBIT growth of -21/4/12%. Non-cig EBIT grew by 12% (7% CAGR over FY14-19).
* GM expanded by 180bps to 64% owing to cig price hikes. Employee/other expense grew by -7/2% resulting in 9% EBITDA growth (11% in FY19 and 7% CAGR over FY15-18). APAT growth of 13% was driven by other income (+54%) and 41bps decline in tax rate.
Stable taxes in FY19 accelerated cig volume/EBIT growth to 5.5/9% vs. -5/7% CAGR during FY15-18. Even then ITC did not enjoy a re-rating as investors flocked towards peers like HUL, Dabur and Britannia etc. Rather, cig business saw a derating (20-25%, based on assigning fair valuation to other segments) over the last 12-months. We believe the quantum of de-rating is unfair and expect implied cig valuation will recover to its 5 year average EV/EBITDA of 18x (20% discount to Colgate’s 1 year forward EV/EBITDA of 22x; similar market leadership, vol growth and pricing power). Mean reversion in cig valuation will be led by (1) Stable taxes, (2) EBIT margin expansion and (3) Pickup in rural consumption. FMCG margin expansion is the other catalyst for a re-rating. We believe that unfair valuation discount will narrow.
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HDFC Securities Limited (HSL) is a SEBI Registered Research Analyst having registration no. INH000002475
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