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In-line Q2; managing margin pressure key ahead

We maintain ADD on ITC given its strong competitive positioning, but near-term margin stress demands enhanced execution. Margin pressure is likely to remain across cigarettes, other FMCG, and paper segments. We maintain SOTP-based TP of Rs520. Q2 result stood marginally ahead of our expectations, aided by better agri business growth. Cigarettes revenue grew 7%, while EBIT grew 5%, affected by 155bps contraction in OPM to 72.4%. Other FMCG (ex-notebook) saw 7% growth, whereas EBITDA margin stood stable YoY. Hotels had a decent show with 12% revenue growth and 15% EBITDA growth (OPM at 31.4%, up by 70bps YoY). Agri saw 47% growth, aided by higher demand for inflationary leaf tobacco, but OPM at 8% contracted by 120bps YoY. Paper saw a lackluster 2% sales growth, though margin continues to wane, now at 11.5% (-380bps).

Cigarettes volume grew 3%; margin contracted by 155bps YoY to 72.4%

Cigarettes business gross sales grew 6%, while net sales growth stood at 7%. We estimate volume growth at 3%. As expected, leaf tobacco inflation has started hurting margin profile. In Q2, the company saw 155bps YoY contraction in the segment margin to 72.4%. After 20% inflation last year, leaf tobacco prices are up 30% in FY25, given weaker supplies from international markets. The company has mitigated margin pressure partially with mix improvement, calibrated price hikes (in the past), and strategic cost management. We see inflationary pressure to have a bearing on segment margin ahead, which ask for price hikes in the portfolio. Assuming no material price hikes ahead, we build gradual recovery in EBIT, implying similar sales and EBIT growth ahead. We arrive at value of Rs248 for the cigarettes on 20x P/E.

Non-cig revenue accelerated to 19%, but margin pressure limit profit growth

Other FMCG business saw muted 5% revenue growth, affected by pressure in notebook (ex-notebook revenue grew 7%). Staples, Biscuits, Snacks, Frozen Snacks, Dairy, Premium Soaps, Home Care and Agarbatti aided growth. Segment EBITDA margin at 10.6% contracted by 35bps YoY (affected by inflationary pressures), resulting in muted 2% EBITDA growth. Hotels revenue and EBITDA grew 12% and 14% YoY with EBITDA margin at 31.4%, increasing by 70bps YoY. Paper, paperboard, and packaging saw 2% growth, whereas EBIT remain stressed with drop of 23% (OPM down by 380bps YoY to 11.5%). Agri business improved with 47% sales growth (aided by leaf tobacco inflation) and 28% EBIT growth (OPM down by 120bps YoY to 8%). Infotech revenue grew 13% YoY to Rs19.9bn, while EBITDA grew 25% with 175bps expansion in OPM to 17.6%.

Slow earnings growth to keep valuations in check; maintain ADD

We see profitability pressure across most segments to have a bearing on earnings growth ahead, which will keep valuation range-bound. Growth is likely to see acceleration with agri business back to healthy growth. We maintain ADD with SOTP-based TP of Rs520.

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