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Holding ground, Q4 cigarette volumes grew 12.8%

Owing to challenging market conditions and receding Covid impact Godfrey Phillips (GP) saw sequential recovery; Q4FY22 revenue/EBITDA/PAT grew 3.6%/6.9%/8.9. Gross revenue for tobacco segment grew 2.8%, backed by 12.8% growth in cigarette volumes. Though nontobacco including TFS remained flat YoY, yet International business including unmanufactured tobacco grew 4-5%. Management said, Omicron disruptions led weak Jan, but Feb/Mar saw strong recovery in key markets in Gujarat/ Maharashtra and J & K. Moreover, with opening up of trade, Marlboro franchise saw robust growth ~25%+ as company also introduced 64mm (Rs6) in strong DSFT markets in East. Gross margin declined marginally to 52.4% (-79bp), with lower employee cost (-22%), ASP (-12%) and other expenses (+10.8%). EBITDA margin expanded 68bp to 22.2%. We remain positive on GP given its focus on RSFT/ DSFT segment, yet expect strong recovery in footfalls for TFS retail business post normalcy in Q1. We retain BUY with revised DCF-based TP of Rs1,498 (13.7x FY24E EPS).

Cigarette volumes recovered sequentially reaching pre Covid levels

Cigarette and other related products net sales grew 3.6% to Rs6.3bn, driven by 12.8% growth in cigarette volumes as in Q4FY21 GP imported Marlboro due to closure of plant. International business including unmanufactured tobacco grew 4-5%. Management said that Q4 growth was lower due to (1) gradual opening of markets – Maharashtra/Punjab/UP (2) improved consumer mobility, (3) faster growth in Marlboro (also added 64mm) and (4) extended ‘Focus’ brand in Gujarat/ Rajasthan/ UP markets (64mm priced at Rs7/-). TFS and chewing tobacco business was flat due to slower recovery in footfalls across its 105 stores. The management expects strong growth in cigarette volumes with change in consumer behaviour post normalcy returning faster

Higher operating leverage resulted in gross margin expansion; EBITDA margin at 21.3%

In Q4, GP’s gross margin marginally declined 79bp to 52.4%, led by higher input costs while product mix remain favourable despite lower employee cost (-22%), and rationalisation of ASP (-12%), yet other expenses grew (+10.8%). EBITDA margin expanded 68bp to 22.2%, though EBIT loss was cut to Rs181mn for TFS. We expect footfalls coming back and normal store operation contribution from higher-margin prepared dishes and foods to drive profitability for TFS.

Improving market conditions to expedite recovery, as long-term growth drivers are intact

In FY22 revenue/EBITDA/PAT grew 9.7%/20.7%/21 with 20% growth in cigarette volume. We note GP’s strategy is driven by (1) driving cigarette volumes across all key markets, (2) focusing on new markets to capture shift in demand towards value-for-money cigarettes, (3) reinforcing partnership with Phillip Morris, acting as key growth engine, (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 cigarette industry. Our discussions with trade partners suggest strong pick-up in cigarette volumes reaching to pre Covid levels which bodes well for GP

Valuation and risks

GP has shown sequential recovery domestic sales, with supply issues behind and higher volume growth, despite disruptions in key states witnessed in Jan/Feb. We remain positive given its focus on RSFT and DSFT segment as it has introduced 64mm price point and expect strong recovery in footfalls for TFS business as mobility across NCR region improved. Company has declared dividend of Rs28 per share in FY22. Considering FY22 performance we have increased earnings for FY23E/FY24E by 0.4%/5.5% and retain BUY with revised DCF-based TP of Rs1,498 (13.7x FY24E EPS). Risks to our call include sharp increase in taxation, significant increase in competitive intensity, and disruption in sales due to lockdowns.

Valuations

GP has shown sequential recovery domestic sales, with supply issues behind and higher volume growth, despite disruptions in key states witnessed in Jan/Feb. We remain positive given its focus on RSFT and DSFT segment as it has introduced 64mm price point and expect strong recovery in footfalls for TFS business as mobility across NCR region improved. Company has declared dividend of Rs28 per share in FY22. Considering FY22 performance we have increased earnings for FY23E/FY24E by 0.4%/5.5% and retain BUY with revised DCF-based TP of Rs1,498 (13.7x FY24E EPS). Risks to our call include sharp increase in taxation, significant increase in competitive intensity, and disruption in sales due to lockdowns.

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