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Stage well-set: supportive tax regime, and now an earnings-beat

ITC’s 3QFY22 earnings report was a positive surprise and delivered a kind of beat (4-5% on profits) that has not been seen for a long time now. Cigarette volumes and profits were both ahead of expectations with volumes (+12% yoy, as per workings; 2-year CAGR of 2%) now well-settled at pre-pandemic run-rate. Overall EBITDA grew 18.2% yoy during the quarter - Cigarettes EBIT +14.4%, Non-cigarettes EBIT +58.6%. With government maintaining a benign stance in Budget 2022, we believe stage is well-set for ITC’s FY23E to be one of the stronger years in recent times on growth fronts. Cigarette volumes just about sustaining the pre-pandemic quarterly run-rate would itself mean a c.4% volume growth for FY23E - we forecast +6% and estimate EBIT growth to be comfortably in double-digit. We see potential for the stock to reverse the long period of lacklustre performance – see ‘Well-positioned for value-creation; we cite three key drivers’ for details.

* Strong beat in operating earnings: ITC reported 31.3%, 18.2% and 12.7% growth in sales, EBITDA and net profit to INR166bn, INR51bn and INR42bn. Segment EBIT was 6.5% better vs our forecast with all segments contributing to the beat. The cigarettes business posted a much stronger-than-expected growth in volumes (c.12% vs JMFe 8%) which has now surpassed the pre-pandemic run-rate. As per management, improved mobility in the country, efficient market servicing and focused portfolio-cum-market interventions aided robust recovery across markets. Improved volumes helped the business deliver a strong 14.4% growth in cigarettes EBIT helped by c.50bps expansion in margin. Double-digit EBIT growth in cigarettes is an important driver of stock momentum, in our view.

* FMCG growth surprised positively after a muted Sep-Q performance: margin progression impacted by the unprecedented rise in commodity prices: FMCG revenue growth of 9.3% was a marked improvement vs c.3% growth clocked in 2Q; higher pricing growth likely helped as well. Biscuits, Spices and Salt grew well within the Staples portfolio but a lot of the growth was boosted more by the recovery in Discretionary and Out-of-Home categories - chips and extruded-snacks, juices and dairy beverages, frozen snacks etc. YTD E-com revenue are up 3x vs two-year ago level and E-com now contributes to 7% of FMCG sales. FMCG EBIT was, however, overall flattish (+1.1% vs -2.7% during 2Q) due to the very steep rise in commodity prices – a phenomenon seen across FMCG players. Margin fell 50bps yoy and is also 80bps lower qoq. Profits are, however, more than 2x vs two-year ago level.

* Hotels, Paperboards and Agri also delivered very strong results: 1) Hotels recovery continued to pick-up pace with revenue doubling yoy (though still 14% below prepandemic level) which helped the business report a profit (INR 506mn vs loss of INR 673mn LY) after six consecutive loss-making quarters. 2) Agri revenue doubled helped by exports of both agri-commodities and leaf-tobacco. Profit growth was relatively slower at 50.6% due to higher share of lower-margin agri-commodities in the revenue-mix. 3) Paperboards had another strong quarter with revenue growth of 38.5% (base was -5%) aided by demand revival across most end-user segments and higher exports. Higher realisations, import-substitution measures and operating-efficiencies helped drove margin higher by 262bps and aided a 57% growth in EBIT.

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