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Godfrey Phillips (GP) reported Q1FY24 results beat our estimates; Revenue/EBITDA/PAT grew 26.2%/ 21.0%/ 115.5% respectively. Gross revenues in Tobacco grew 28.7%, backed by 8.1% volume growth in cigarettes and 120% growth in leaf tobacco exports to Rs3.1bn, whilst nontobacco (TFS+Funda Goli) grew 8.1%. GP’s performance was driven by, (1) clear focus on cigarette business, (2) expanded distribution for Marlboro led to 30% contribution, (3) strong exports of leaf tobacco and (4) PMI (associate company) now wiped out losses and fuelled dividend income. Gross margin declined by 510bp to 46.5% due to higher RM inflation coupled with higher exports of leaf tobacco and cigarettes. EBITDA at Rs2.4bn grew by 21.0% despite higher other exp. (+23.9%) and employee cost (+11.8%) settling EBITDA margin at 23.2% (- 100bp). GP has strong focus on RSFT segment, yet expanded footprint for TFS (146 stores) to reflect lowering losses. Checking better performance and higher other income, we increased our earnings and retain BUY, with a revised DCF-based TP Rs2,383 (implying 13.6x FY25E EPS). Cigarette volumes dropped sequentially while crossed pre Covid with 8.1% growth

Cigarette volumes dropped sequentially while crossed pre Covid with 8.1% growth In Q1FY24 GP’s net sales grew 26.6% to Rs10.3bn, driven by 8.1% growth in cigarette volumes trailed by 120% rise in in cut and unmanufactured tobacco exports. With closure of chewing business, GP has clear focus on driving cigarette business coupled with expanded distribution of Marlboro portfolio helped to achieve 26% growth in volumes. Marlboro franchise mow make up 30% contribution led by ‘Marlboro-Compact’ priced at Rs10. Management said growth was led by, (1) normalised consumer activities, (2) higher demand in core markets J&K/Mah/ Guj/Raj, (3) faster growth in Marlboro, (4) growing reach for ‘Focus’ brand and ‘Stellar’ in south and (5) higher dividend income of Rs756.4mn from associate company. TFS including ‘Goli’ grew 8.1% to Rs1.1bn. GP saw strong recovery in footfalls TFS and stores/kiosks stood at 146.

Higher share of unmanufactured tobacco sales cut gross margin by 510bp In Q4, GP’s gross margin declined to 46.5% (-510bp), led by 120% growth (Rs3.1bn) in cut and unmanufactured tobacco exports and also sharp increase in prices in leaf tobacco and cigarette packaging prices. EBITDA at Rs2.4bn grew 21.0% despite higher other expenses (+23.9%) and employee cost (+11.8%); EBITDA margin slipped to 23.2% (-100bp), +420bp QoQ. With 24% EBIT margin for tobacco business, losses in TFS retail business dropped at Rs165.3mn. We expect operating leverage and higher contribution margin from prepared foods to lift profitability.

Management expects sustained growth momentum, as long-term growth drivers are intact We reckon GP’s growth strategy is driven by (1) focusing on new markets to capture shift in demand towards value-for-money cigarettes, (2) reinforcing partnership with Phillip Morris, acting as key growth engine, (3) strengthening export markets, and (4) capitalizing on fast-growing TFS business. We expect GP to effect price increase across portfolio in Q2 given rising RM/PM prices. In addition, steady dividend income from associate company would help it to drive PAT.

Valuation and risks In line with our argument, cigarette industry witnessed strong volume growth in FY23 led by premiumsiation (Marlboro) and higher sales in RSFT segment, and the trend would continue in FY24 as well. We believe strong tailwinds for RSFT segment and also Marlboro entry into the DSFT segment (64mm). With increased footprint for TFS we expect operating leverage to drive profitability, yet cut losses. We remain hopeful on rural recovery which could provide strong tailwinds for GP. Considering dividend income from associate and lower losses in TFS, we increased earnings for FY24E/25E by 13.6% each with a revised DCF-based TP Rs2,383 (implying 13.6x FY25E EPS). Risk: sharp increase in taxation and higher competition.

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