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Broad-based sales growth drives EBITDA beat

* Sales growth momentum was better than expected across businesses in 1QFY23. Barring the Agri business, where the ban on wheat exports may result in relatively muted growth in subsequent quarters, momentum in other businesses is expected to remain robust.

* As highlighted in our upgrade to Buy note as well as our FY22 annual report note, strong earnings momentum (16% EPS CAGR over FY22-24 v/s ~5% in the preceding five years) is being led by good performance from Cigarettes in a stable tax environment, healthy recovery in profitability for the Hotels business, and continued good performance from FMCG-Others. Unlike peers, pressure on material costs is far lower. Allied with better capital allocation and continued healthy dividend payout, the path towards high 20s or early 30s RoE is visible. We maintain our Buy rating

EBITDA beat on strong growth across segments, led by the Agri business

* Net revenue grew 41.5% YoY to INR172.9b (est. INR148.8b). EBITDA rose 41.5% YoY to INR56.5b (est. INR50.8b). PBT/adjusted PAT grew 38%/38.4% YoY to INR55.4b/INR41.7b (in line).

* Gross margin fell 170bp YoY to 51% (est. 54.5%), while EBITDA margin remained flat YoY at 32.7% in 1QFY23 (est. 34.1%).

* Cigarette volumes are likely to have increased by 26% YoY in 1QFY23 (est. 11%). Volume growth in the base quarter was 31%. However, three-year volume CAGR stood at 1.3%. Net Cigarette sales grew 27.4% YoY to INR55.8b (in line). Cigarette EBIT grew 30.1% YoY to INR41.9b (est. INR40.3b). Three year Cigarette EBIT CAGR stood at 2.9%. Net Cigarette EBIT margin expanded by 160bp YoY to 75.1%.

* FMCG-Others sales grew 19.5% YoY to INR44.5b. EBIT rose 17.6% YoY to INR2b in 1QFY23.

* Sales from the Agri business grew 82.7% YoY to INR74.7b.

* Sales from the Paperboards business rose 43.3% YoY to INR22.7b.

* Sales from the Hotels business increased by 336% YoY to INR5.5b.

* Other income fell 27.1% YoY to INR3.1b.

Valuation and view

* Changes to our model have resulted in a 3%/4% increase in our FY23/FY24 EPS estimate. If not for the significant compression to other income from the mark-to-market impact on bond investments in 1QFY23, the increase in our EPS forecasts would have been higher.

* We have turned constructive on the stock, led by: a) a better than expected demand recovery and a healthy margin outlook in Cigarettes, b) robust sales momentum in the FMCG business, c) lower drag from the Hotels business, and d) better capital allocation in recent years.

* A stable tax environment for Cigarettes in recent years has allowed ITC to calibrate price increases to avoid a disruption in demand. We expect this trend to continue and result in improved Cigarette volumes and earnings visibility over the medium-term.

* While valuations of global Tobacco peers have returned to pre-COVID levels (Jan'19), at 18.8x FY24 EPS, ITC still trades at a 26% discount to its Jan'19 valuations of 25.4x one-year forward EPS. We maintain our earlier assigned 21x EPS multiple, a 65% premium to its global peer average, and roll forward to Jun’24 earnings The stock has done well, with gains of ~17% since our upgrade to Buy in Jun’22. We see scope for further upside, based on a healthy earnings outlook. We maintain our Buy rating.

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