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Cigarette recovery to drive upsides

* ITC reported a sequential recovery in Q3. Cigarette sales/EBIT declined 8%, in line with estimates. PBT fell 6% to Rs48.5bn, 5% below estimates, due to a slight miss on margins in FMCG, Agribusiness and Paper. PAT declined 12% yoy on lower ETR in Q3FY20.

* Cigarette recovery continued mom with Dec20 being better. Further reopening and stable taxation should support recovery and growth in cigarettes sales/EBIT ahead. ITC’s initiatives on portfolio expansion and innovations targeting gaps appear positive.

* FMCG comparable growth of 11% and EBITDA margin expansion of 150bps (230bps including Sunrise) were healthy but lower than expectations due to moderation in staples/ convenience foods and high ad spends. Strong traction in the Health & Hygiene portfolio, pick-up in ESPB and aggressive innovation should boost growth and margin gains.

* We keep estimates unchanged currently and believe that further recovery in cigarettes and other divisions can lead to an upgrade in FY22/23 forecasts. ITC’s increased aggression on innovations and cost efficiencies are encouraging. Valuations at 16x FY23E provide attractive upsides. Maintain Buy with a revised TP of Rs265, based on 18x Mar’23E EPS.

Cigarette recovery in-line; expect full recovery in Q4: Cigarette sales declined 8% (post excise adjustments), with a similar volume decline. The decline was limited by a recovery in metros and uptown markets; management also mentioned MoM improvement. EBIT margins were down only 20bps, driven by cost control measures, restricting the EBIT decline to 8%. Variants in Gold Flake and Navy cut have been launched at competitive price points to address competition, resulting in market share gains of 10-20bps. Cigarette recovery continued mom with Dec20 being better. Further reopening, stable taxation and ITC’s initiatives on portfolio expansion and innovations targeting gaps should support recovery and growth in cigarettes sales/EBIT ahead.

FMCG comparable growth at 11%; mixed performance of other divisions: FMCG sales grew 8% (11% comparable growth), with Staples, Convenience Foods and Health & Hygiene products growing at 11%. Sales in the discretionary category bounced back to 11% vs. -2%/- 25% in Q2/Q1. FMCG margin improvement was slightly below expectations due to higher commodity costs and IPL-led higher ad spends in Q3. EBITDA was up 28% and margins were up 140bps to 9.2% (10% including Sunrise) vs. a 290bps gain to 9.7% in Q2. Agri business grew 19%; margins declined 230bps on lower leaf tobacco exports. Paper fell 5% with a 15% EBIT decline on softer realizations and weak mix. Hotels picked up qoq and turned EBITDA positive in Dec’20 on strong cost savings.

Further recovery may drive upsides; maintain Buy: We keep estimates unchanged currently but believe that further recovery in cigarettes/other divisions can lead to an upgrade in FY22/23 forecasts. ITC’s increased aggression on innovations and cost efficiencies are encouraging. Valuations at 16x FY23E provide attractive upsides. Maintain Buy with a revised TP of Rs265 (from Rs250 earlier), based on 18x Mar’23E EPS.

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