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Splendid growth continues in cigarettes, FMCG

About the stock: ITC is biggest cigarettes & second largest FMCG company in India with ~78% of market share in cigarettes & presence in staples, biscuits, noodles, snacks, chocolate, dairy products & personal care products. The company is also present in paperboard, printing & packaging business, agri & hotels businesses.

* The company has more than 200 manufacturing facilities in India. It has a distribution reach of over 6 million retail outlets across various trade channels & strong 25 brands across various categories

Q2FY23 Results: ITC reported splendid growth across segments.

* Sales were up 26.6% YoY, led by 23.3% cigarettes sales growth with cigarette volumes up by ~20% (vs. I-direct estimate of 10% volume growth)

* EBITDA was at | 5864.3 crore, up 27.1% YoY, with margins at 34.2%

* Consequent PAT was at | 4466.1 crore (up 20.8% YoY)

What should investors do? ITC’s share price gave a return of 30% in last five years (from | 269 in October 2017 to 350 in October 2022) underperforming FMCG index

* We raise our cigarette volumes growth estimate from 10% to 13% for FY23E. We also incorporate higher hotel occupancies and ARRs after factoring in strong H1FY23 performance and future outlook

* We maintain our BUY recommendation

Target Price and Valuation: We value the stock at | 405 on SOTP basis valuing cigarettes business 18x FY24 earnings & FMCG business 6x FY24 sales

Key triggers for future price performance:

* Stable taxation on cigarettes is expected to maintain current volumes runrate. The company has been gaining market share in cigarettes from last one year through new premium products & trade promotions

* FMCG business growing at a sustained pace with continuous improvement in margins in last five years. Large opportunity size of existing foods (Atta, Biscuits, Juices, Noodles, snacks, Chocolate & dairy) portfolio would help in growing the business at faster pace compared to other FMCG companies

* Hotels business in occupancy levels has crossed 70% & ARRs are above pre-pandemic levels. We believe it would continue to grow at a faster pace in the near term factoring in pent-up demand

Alternate Stock Idea: We also like Dabur in our FMCG coverage.

* Significant shift in consumption towards healthier, natural & Ayurveda based products & aggressively foray in many big categories would be driving growth for Dabur

Key takeaways of recent quarter

Q2FY23 Results: Robust cigarettes volume growth, FMCG business also on growth path

* Revenue witnessed growth of 26.6% to | 17159.6 crore led by splendid growth in cigarettes, FMCG & paperboard segments. Agri & hotels business also grew at stronger pace on the back of lower base quarter sales

* Cigarettes business sales were up 23.3% led by ~20% volume growth & ~3% product mix improvement. Stable taxes & action on illicit cigarettes by enforcement agencies is driving volume growth. Segment profits have grown by 23.6% to | 4429 crore maintaining margins

* Cigarettes volume has been driven by new product launches at premium end and aggressive trade promotions. The growth has been secular across regions & markets

* FMCG business growth of 21% was led by strong performance across categories except hygiene product portfolio. Moreover, fully functional education institutes are also supporting strong growth in education & stationary category

* FMCG margins (EBITDA) contracted by merely 50 bps to 9.5% despite high inflationary pressure. It is important to note that operating margins expanded by 280 bps compared to Q2FY20 (pre-pandemic quarter)

* The company is growing its presence in the e-commerce channels with presence in quick commerce, modern trade & D2C platform. Its D2C platform is now present in 14 cities with 700+ products in 45 categories

* ITC has a strong new product pipeline in existing categories with focus on premiumisation. Its product portfolio includes salt, Vermicelli, Cow Ghee, healthy beverages. The company is leveraging its existing brands for expanding presence in high opportunity size categories

* Paperboard business growth of 25% was largely led by pricing growth in Q2. The end user industries of paperboard business have been clocking higher than pre-pandemic volumes

* Paperboard segment profit for the business has grown 54% to | 630 crore with 518 bps improvement in margin to 27.5%. The state of the art facility in Nadiad, Gujarat commenced operations in Q2

* Hotels business occupancy levels has crossed 70% (except for newer properties). Further average room revenue (ARRs) has been higher than preCovid levels. Operating margins (EBITDA) were at 29% higher by 860 bps compared to the Q2FY20 (pre-Covid period)

* ITC Narmada, a luxury 291-key hotel in Ahmedabad was launched in August-22. The company has healthy pipeline of properties under Welcome hotels, Mementos, Storii & Fortune brands, which would be open in phased manner in next few quarters

* Though agri business has grown at 44% YoY on a low base, it is down 47% sequentially after export ban on wheat. However, wheat contracted for exports before the ban were allowed to export during the quarter. Agri exports largely constitutes wheat, rice & leaf tobacco

* ITC would be commencing operations of its Mysuru plant in Q4FY23. The facilities would manufacture Nicotine & Nicotine derivative products for exports. It would also commission spice facility in Guntur soon

* The company maintained its gross & operating margins despite huge commodity pressure in FMCG business. We believe impact of commodity inflation have been offset by operating leverage

* Operating profit grew 27.1% to | 5864.3 crore with sustained operating margin at 34.2% (12 bps up). Other income was down 25.1% to | 506.9 crore given reduction in cash & investments after company adopted the policy of 85% dividend payout. Net profit grew 20.8% to |4466.1 crore

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