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Margins to play a key part in driving FY24 earnings growth

ITC Ltd. (ITC) 4QFY23 revenues were largely in-line with our estimate, as miss on cigarette volume was compensated by decent sequential improvement in Agri business revenues (driven by growth in value-added agri products and leaf tobacco exports) along with strong growth in Hotels. EBITDA margin (EM) improvement for the FMCG-Other segment to its highest ever level was a big positive (with 13.3% EM in 4Q, it ended the year at 10.2% EM) slightly offset by a lower-than-expected Paperboards, Paper & Packaging (PPP) operating performance. Restrictions imposed on wheat & rice exports will have a sharp impact on overall revenue growth in 1QFY24 due to very heavy base. Hence, improvement in overall margin will play a key part in driving double digit earnings growth in FY24. We are we building a relatively subdued 11.4% EPS CAGR over FY23-FY25E. Due to limited upside on one-year basis, we downgrade the stock to NEUTRAL (ADD earlier) with a revised target price (TP) of Rs450.

Result Highlights

* 4QFY23 headline performance: ITC’s 4QFY23 standalone topline (adjusted for excise duty) was up 5.6% YoY to Rs164bn. EBITDA was up 18.9% YoY to Rs62bn. Adjusted PAT (APAT) was up 20% YoY to Rs50.3bn.

* Cigarette revenue grew by 14.2% YoY, up ~7.6% on a 4-year CAGR basis. We believe cigarette volumes (calculated) to have grown by around 12-13% (vs our est. of 16%).

* Overall margins: Gross margin was up 540bps YoY to 58.6% (but down 30bps QoQ). EBITDA margin was thus up 420bps YoY at 37.9%.

* FY23 performance: Revenue, EBITDA and APAT grew 17.2%, 26.5% and 24.2%, resp. EBITDA margins was up 270bps YoY to 36.3%

Key highlights from Presentation

(1) FMCG-Others segment: (a) Input costs remain at elevated levels, even as some of the commodities witnessed sequential moderation in prices. (b) Segment EBITDA margins expanded to 10.2% in FY23 amidst severe inflationary pressures driven by premiumisation, supply chain agility, judicious pricing actions, digital initiatives, strategic cost management and fiscal incentives (including PLI).

(2) Paperboards, Paper & Packaging (PPP) segment: (a) In 4QFY23, planned shutdown of pulp mills for capacity expansion impacted performance. (b) Pulp prices softened after a sharp rise in the first half of the year. Fine Paper segment remains buoyant; muted demand in global markets in Paperboards

View & Valuation

There is 2.8%/3.2% upward revision in our FY24E/FY25E EPS as we expect better margins in FY24/FY25. What’s working well for ITC in recent times: (1) Stable taxation regime and share gains from illicit trade is supporting cigarette business. (2) FMCG-Others business growing at healthy rate and now also showing signs of better profitability led by structural investments of the past along with scale, innovations, growing reach, moderating inflation, etc. (3) Strong overall performance in the Hotels business post Covid recovery. But restrictions imposed on wheat & rice exports will have a sharp impact on 1QFY24 revenues due to very heavy base, dragging full year topline growth. We model revenue CAGR of 8.2% over FY23-25E. Better mix and a moderating inflationary environment should improve margins. We expect an EBITDA CAGR of 11.9% over FY23-25E, contingent on strong gross margin improvement. Dividend payout remains best-in-class. Return ratios have improved in FY23 and are expected to improve further as major capacity exercise is done. ITC has delivered strong return over the last one year (up ~57%) and the stock is currently trading at ~24x/22x on FY24E/FY25E EPS, as we build relatively subdued 11.4% EPS CAGR over FY23-FY25E. Due to limited upside on one-year basis, we downgrade the stock to NEUTRAL (ADD earlier) with a revised TP of Rs450 (Rs420 earlier), valuing it at ~24x March’2025E EPS (implied Mar’24E PE multiple of ~26x; 3yr/5yr avg fwd. multiple at: ~18x/20x).

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