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Strong recovery in cigarette volumes in Q1

Despite challenging market conditions, Godfrey Phillips (GP) saw sequential recovery post June. Q1FY22 revenue/EBITDA/PAT grew 49.8%/157%/108.8%, beating our estimates. Cigarette volumes grew 57.4%. International business grew 47% in value terms. With supply chain issues behind, management indicated Marlboro supported volume growth.

Gross revenue grew 68.2% for tobacco segment; non-tobacco segment including TFS grew 15%. Favorable product mix and higher scale of operations resulted in 482bp gross margin expansion to 54.1%. Despite rising employee cost (+27.3%) and ASP (+55.9%), EBITDA margin expanded 957bp to 23%. Management said July/August saw strong month-onmonth recovery. It expects further pick-up in exports and domestic sales, with improving consumer mobility and relaxations post vaccination driving OOH consumption. Our earnings estimates are unchanged. BUY with a DCF-based TP of Rs1,310 (15.1x FY23E EPS).

Cigarette volumes recovered sharply

Cigarette and other related products posted a net sales growth of 49.8%, driven by 57% growth in cigarette volumes; exports grew 47%. Management said that the revival in Q1 was led by (1) recovery to pre-Covid levels in June, (2) gradual increase in consumer mobility in top cities, and (3) faster pace of trade promotions. TFS and chewing tobacco business grew 15%, despite only 93 stores being open; the company expects strong recovery in footfalls in TFS stores in Q2. The management said that consumers opting for contactless shopping through e-commerce led to slower offtake for processed food in Q1.

Higher scale resulted in gross margin expansion; EBITDA margin expanded to 23%

In Q1, GP’s gross margin expanded 482bp, led by (1) favorable product mix, (2) lower share of traded goods, and (3) higher operating leverage. Despite rise in ASP (+55.9%), employee cost (+27.3%), and other expenses (+29%), EBITDA margin expanded 957bp to 23%. EBIT margin declined for TFS, as only 93 stores were operational in Q1 and contribution from higher-margin prepared dishes and foods was lower.

Easing lockdowns to improve pace of recovery, as long-term growth drivers are intact

GP’s strategy is driven by efforts such as (1) driving cigarette volumes across all key markets, (2) focusing on new markets to catch the shift in demand towards value-for-money cigarettes, (3) reinforcing partnership with Phillip Morris, acting as key growth engine for its distribution efforts, (4) strengthening existing export markets, and (5) capitalizing on fast-growing retail space through TFS, using product innovations. However, increase in competition and surge in discounting to counter illegal imports and local counterfeits remain challenges for the industry. Our discussions with trade partners suggest strong pick-up in value-for-money cigarettes, which bodes well for GP, given its focus on this segment. Also, expected pick-up in footfalls should drive TFS revenues.

Valuation and risks

GP has shown strong recovery in Q1, with supply issues behind, resulting in volume growth. We believe GP could benefit from strong tailwinds for RSFT/DSFT segment and entry into the South with its Marlboro brand. Considering the gradual easing of lockdowns post the second Covid wave, we expect rebound in sales. We retain our earnings estimates and maintain BUY with a DCF-based TP of Rs1,310 (15.1x FY23E EPS). Risks to our call include sharp increase in taxation, significant increase in competitive intensity, and disruption in sales due to intermittent lockdowns.

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