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Mixed results with strong margins offsetting revenue disappointment; use result or tax hike concern-led weakness to BUY

Our view

ITC delivered a mixed performance with a revenue disappointment in FMCG and cigarettes segments and an unexpected fall in agri business, which was offset by resilient margins in cigarettes/FMCG and strong improvement in agri business and hotels. While muted cigarette volumes was a major drag on Q2 performance, we expect normalized growth in cigarette volumes from 4Q onwards (barring any unexpected tax increases) and better growth rates in agribusiness and FMCG, in addition to margin improvement especially in cigarettes with positive operating leverage and a better mix.

Hotels business should improve steadily while paper business margin reinforces confidence in ITC’s focus to enhance competitiveness. We believe the cigarettes business deserves better valuation given positive volume growth expectations, improving geography and product mix and high ESG rankings. The FMCG business is growing well with acquisitions supporting the organic growth and margins moving up with scale. In other businesses, capital allocation concerns are being addressed with the peak capex cycle behind us, while the IT business can be another key value driver.

Result Highlights

* Result summary –

Revenue growth of 14% YoY (on a base of 4% decline in Q2FY21) led by paperboards, steady performance from FMCG and smart recovery in Hotels business. EBITDA margin improved 360bps QoQ however flat YoY driven by premiumization, calibrated price hikes and focused cost control initiatives. PAT grew 14.4% YoY aided by better margin performance.

* Segmental performance (Standalone) –

Cigarettes saw 10.2% revenue and 10.4% EBIT growth, FMCG saw 6.4% revenue and 7.6% EBIT growth, hotels saw 3.6x jump in revenue on Covid-led washout in base quarter and loss of Rs 480mn at EBIT level, agribusiness revenue de-grew 7% while registered 15.7% EBIT growth and paper saw 25.4% revenue growth with 23.8% EBIT growth.

Valuation

We build in 8%/10%/9% revenue/EBITDA/PAT CAGR for the company over FY21- 24E. Solid dividend yield and cash flows coupled with receding capital allocation concerns should keep the sentiment positive on the stock. We reiterate our BUY rating and a TP of Rs 283 based on 20x FY24E earnings, a significant discount of 50-60% to sector peers and a 15% discount to its own long-term average multiple. Any incremental tax increase or unrelated diversification remain the key risks.

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