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Cigarette EBIT miss; near-term volatility to continue

* ITC reported a 22% YoY decline in consolidated net cigarette revenue (INR104.1b) vs. our expectation of an 18% decline. Given a sharp increase in taxes, ITC has adopted a calibrated price hike strategy (unlike immediate tax pass-on historically) to protect the loss of consumers to illegal cigarette markets. Volume declined by high single digits. Cigarette price hikes are still in progress, and the cumulative hike has not reached the tax-neutral level. Consolidated EBIT declined by 32% YoY to INR37.7b (est. INR41.1b). Standalone EBIT fell 35% YoY.

* Consol. FMCG segment sales grew 15% YoY (in line). Standalone FMCG revenue grew 12% (up 16% ex-staples). EBIT rose 22% YoY to INR4.9b (est. INR5.2b), while EBIT margin expanded by 40bp (-180bp in base) to 7.3%.

* Agri business sales declined 16% YoY to INR81.4b (miss), impacted by geopolitical disruptions and a high base, and EBIT margin contracted by 10bp YoY to 4.4% (est. 6.5%). Paper business sales grew 9% YoY to INR23.1b, EBIT rose 43% YoY to INR2.2b (est. INR2.7b), and EBIT margin expanded by 220bp YoY to 9.4%.

* In cigarette business, the pass-through of the tax hike to consumers is still in progress. Thus, cigarette revenue and EBIT performance would remain weak. Earnings pressure on cigarettes offsets the benefits of recovery in FMCG and Paper. ITC has been trying to lower the tax impact (launched 30 new SKUs recently), but the sharp tax increase and competition from illicit cigarettes would take time to normalize. A calibrated price hike will continue to impact cigarette EBIT performance in the coming quarters. We maintain our Neutral rating on ITC with our SoTP-based TP of INR300 (implying 18x FY28E EPS).

Cigarette EBIT down 35%; In-line FMCG performance

* Consolidated performance: ITC’s 1QFY27 net revenue declined 11% YoY to INR191.1b (est. INR219b). EBITDA fell 24% YoY to INR 51.8b (est. INR59.4b). PBT and APAT decreased by 23% and 22%, respectively.

* Net cigarette sales down 25%; EBIT dipped 35%: Consolidated net cigarette sales declined 22% YoY to INR61.9b (est. INR61.7bn) given the sharp increase in excise duty. Standalone cigarette net revenue fell 25%. Consolidated EBIT declined by 32% YoY to INR37.7b (est. INR41.1b). Standalone EBIT decreased by 35% YoY. Management highlighted that it adopted staggered and agile pricing actions to minimize the loss to illicit trade while protecting its consumer franchise. ITC is still under the transitory phase in terms of passing on the entire tax hike to consumers. We believe cigarette revenue and EBIT performance will remain volatile.

* Healthy FMCG performance: Consolidated FMCG-Others sales grew 15% YoY to INR66.9b (est. INR66.7b). Standalone FMCG revenue growth was at 12% (exstaples up 16%). Dairy, Snacks, Noodles and Frozen Snacks delivered strong growth of over 20% YoY, and the Personal Care portfolio registered mid-teen growth during the quarter. Atta business remained impacted by transient factors, including heat waves, LPG shortages, and benign wheat prices. Notebooks business registered a strong rebound during the quarter, reflecting improving business momentum. EBIT grew 22% YoY to INR4.9b (est. INR5.2b) in 1QFY27. EBIT margin expanded by 40bp to 7.3% (est. 7.8%). The sharp cost increase in fuel, edible oil, soap noodles, packaging inputs, etc. amid the West Asia conflict is cushioned by strategic inventory covers & commodity hedges. The impact is proactively mitigated through focused cost-management initiatives, smart net revenue management and price-volume rebalancing. Digital-first and organic portfolio maintained strong growth momentum, with ARR surpassing INR15b.

* Agri business sales fell 16% YoY to INR81.4b (est. INR107.9b), impacted by the West Asia conflict-led trade disruptions and a high base in 1QFY26. EBIT fell 17% YoY to INR3.6b and EBIT margin contracted by 10bp YoY to 4.4% (est. 6.5%).

* Paperboard sales grew 9% YoY to INR23.1b (est. INR22.6b), EBIT rose 43% YoY to INR2.2b, and EBIT margin expanded 220bp YoY to 9.4% (est. 12%). ITC saw broad-based improvement in net realizations, while wood costs moderated on a YoY basis. Both the Flexibles and Cartons packaging portfolios delivered robust growth during the quarter. Cost escalations in West Asia were effectively mitigated through agile cost management initiatives and judicious pricing actions.

Valuation and view

* We cut our EPS estimates by 2% for FY27 and FY28.

* The price hike on cigarettes is slower than expected and is expected to impact earnings in FY27. This strategy can lower the loss of consumers to illegal cigarettes, but it is adding a near-term earnings risk.

* ITC is still under the transitory phase in terms of passing on the entire tax hike to consumers. Thus, we believe the cigarette revenue and EBIT performance will be volatile in the near term.

* FMCG business continues to perform well with robust improvement in margins. However, we believe earnings pressure on cigarettes would offset the near-term catalysts (recovery in FMCG and Paper) and comfort on valuation. ITC has a full cigarette portfolio to better navigate the tax increase, but competitive pressure from illicit cigarettes will take a toll on the formal cigarette industry.

* We maintain our Neutral rating on ITC with our SoTP-based TP of INR300 (implying 18x FY28E EPS).

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