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Earnings visibility continues to drive outperformance

As consumer companies continue to struggle in an uncertain operating environment, ITC is better placed than peers with accelerated earnings growth over the past two years, especially in FY23, and strong earnings visibility compared to peers into FY24 as well. Key factors behind its positive outlook are:

* Healthy cigarette volume growth in the recent quarters is likely to sustain in the near term, leading to the best three-year and four-year average volume growth for over a decade.

* With no high indirect tax increase in the FY24 budget, the operating environment is far more conducive compared to the punitive regime of the preceding years.

* Over the past five to six quarters, the company has sparingly used its pricing lever and can continue to take leverage on the same going forward.

* Unlike staples peers, the company has displayed resilient operating performance of its ‘Other FMCG’ business in the past few quarters. If wheat costs decline sharply post the Rabi harvest, performance on the segmental margin front can be even better in FY24.

* Hotels business prospects are likely to be buoyant going forward as highlighted in our thematic report on hotels by our mid-cap team.

* We maintain our Buy rating on the stock as a result of (a) better earnings visibility over peers in the next few quarters, (b) inexpensive valuations; and (c) attractive dividend yield.

Cigarette business outlook remains healthy

At a time when consumer companies have witnessed a slowdown, cigarette volumes for ITC have registered a strong double-digit YoY growth in the recent quarters and three-year and four-year average volume growth have been in midsingle digits. This has been the best growth levels in over a decade and far superior to the flattish volumes of the past 10 and 20 years. In a relatively less stringent indirect tax environment, ITC is better placed owing to its judicious pricing actions and its recent recuperation of some temporary market share loss in the capsule segment. Smuggling has also been a relatively lower factor due to government crackdown as well as a less punitive indirect tax regime compared to the past.

Absence of material tax increases in the budget is a relief

In the FY24 national budget, National Calamity Contingent Duty (NCCD) on all four filter cigarette categories viz. less than 65mm, 65-70mm, 70-75mm, and above 75mm was increased by 15-16%. However, the total NCCD across these segments is less than 10% of the total indirect taxation, which is ~60% of MRP. Hence, the effective increase would be less than 1%, dodging a significant hurdle in the near term. While subsequent GST council meetings can drive up cigarette GST, the outlook on cigarette volumes looks positive as of now.

‘Other FMCG’ growth momentum remains strong; better times ahead

ITC’s ‘Other FMCG’ segment (the second-largest contributor to sales) is also witnessing strong sales and earnings momentum unlike most consumer staples peers. Over the past three quarters, ‘Other FMCG’ Sales growth has been hovering in high teens to early 20% at a time when staples peer growth is much lower. This is also despite a significantly high base in terms of absolute scale. We expect ‘Other FMCG’ business to register revenue of over INR190b in FY23, the fourth largest in our coverage universe after HUVR, TTAN, and APNT. Margins have been resilient, registering a YoY growth in the recent quarters, despite steep inflation in commodity costs. The likelihood of a good Rabi season could lead to substantial cooling off in wheat prices from 1QFY24 onwards, which could boost ‘Other FMCG’ further in FY24.

Outlook for Hotel business bright

The Indian hospitality industry has been witnessing steady rise over the recent quarters as highlighted in our recent Hotel business thematic note by our mid cap team. For ITC, the Hotel business sales and EBIT are witnessing new highs after over a decade, with the adverse impact of overcapacity fading away. Within discretionary consumption, this segment has not been significantly impacted by the ongoing consumption slowdown and with various events such as the G20 summit, women’s and men’s IPL tournaments, and the Cricket World Cup in FY24, outlook for the industry appears to be bright

Valuation and view

* ITC has demonstrated a healthy 23% EPS growth in FY23E and we expect a likely EPS CAGR of ~15% over the next two years as well. ITC’s earnings outlook is better than other large cap staples players both on a two-year CAGR ending FY23E as well as FY24 earnings growth expectations.

* At a time when uncertainty looms over the industry, led by high inflation, unpredictable monsoons, continued weak rural sales, and delay in commodity costs decline, ITC’s earnings performance in the last couple of years and in FY24 shines like a beacon.

* The stock has done well since our detailed upgrade note in Jun’22 with ~45% stock price appreciation at a time when consumer peers both staples, and recently, discretionaries have struggled. ITC’s dividend yield is healthy at 3.5-4% despite the stock price appreciations and valuations remain inexpensive at 22.2xFY24 EPS and less than 20xFY25 EPS.

* The challenges for ITC led by (a) an extremely punitive tax regime of the past, (b) covid related disruptions and (c) commodity cost inflation now seems to be receding. We maintain BUY rating and our target price of INR450.

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