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Steady performance; stable tax policy remains key

* Q2 performance was slightly ahead of estimates, with PAT growth of 14%. Cigarette sales/EBIT grew 10% yoy, recovering to 95% of pre-Covid levels. FMCG grew 3% yoy on high comparables (2-year CAGR 11%) and maintained 10% EBITDA margins.

* Cigarette recovery appears healthy with exit volumes at near pre-Covid. A further increase in mobility and ITC’s initiatives on portfolio expansion should drive a healthy recovery. However, a stable taxation policy remains key to sustaining steady growth ahead.

* FMCG sequential trends indicate a likely pick-up in growth in H2 as the base normalizes. Increasing cost pressure may, however, limit margin gains in the immediate term. Other divisions (Hotels/Agri/Paper) saw strong growth (EBIT up 63%), led by Paper/Hotels.

* ITC’s IT business has seen strong rise in its profitability (PAT up 70% in H1) and we now value it at Rs12/share. We maintain Buy and arrive at a fair value of Rs270, based on a two-stage DCF growth model with a derived target PE multiple of 17.6x (Dec’23E EPS).

Healthy recovery in cigarettes; exit volumes at pre-Covid levels: Cigarette sales grew 10% (post excise adjustments), with similar volume growth. ITC witnessed a broad-based recovery in cigarette volumes across markets, exiting Q2 with volumes near pre-Covid levels. Certain markets in Kerala and East remained muted. Underlying EBIT grew 10%, with margins up 10bps YoY. Growing stockist network (2.1x YoY), rural servicing infrastructure (1.1x YoY) and step-up in innovative offerings should support faster recovery and growth in cigarette sales/volumes ahead. A stable taxation policy remains key for steady growth ahead. Recent government steps to form a panel to suggest raising taxation on tobacco, however, may remain a near-term overhang.

Softer growth in FMCG on a high base; margin gains higher despite cost pressures: FMCG sales grew 3%, led by a slowdown in demand for staples and hygiene products against very high comparables. The 2-year sales CAGR was still healthy at 11%. Out-of-home categories recorded strong growth. Despite inflationary trends in input prices, EBITDA margin was sustained at 10%, led by cost savings, favorable mix, premiumization and fiscal incentives. E-commerce sales stood at 7% of overall sales for H1FY22 (2x of H1FY21). The Paper business delivered a strong performance, with Sales/EBIT up 25%/24%. Hotels business continued to witness strong recovery trends with easing travel restrictions leading to higher occupancy levels (3x of Q2FY21). ITC Infotech continues to exhibit strong growth trends, with a 1.7x jump in profitability in H1FY22.

Earnings momentum improving, maintain Buy: Cigarette recovery has been healthy, and stable taxation remains key to sustaining category growth ahead. The performance of the IT business has been notable and we now value it at Rs12/share. At 17x FY23E EPS, the valuation appears reasonable. We maintain Buy and arrive at a fair value of Rs270, based on a two-stage DCF growth model with a derived target PE multiple of 17.6x (Dec’23E EPS).

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