ITC Rating ‘Buy’; FMCG-Others business drove sales beat

ITC’s standalone net sales were up 0.9% y-o-y, while Ebitda/PAT declined by 11%/19.7% y-o-y, respectively. Sales were 7.6% ahead of consensus, while Ebitda/PAT were largely in line with consensus expectations. This strong revenue beat was largely driven by the strong underlying performance of the FMCG-Others business, which grew by 18% y-o-y on a comparable basis and delivered significant margin expansion, leading to 66% segment Ebitda growth, which in our view is the key highlight of the result.

Segment highlights
(i) Cigarette sales/Ebit were down 3.9%/15.6% y-o-y for the quarter, driven by localised lockdowns; (ii) FMCG-Others reported very strong quarter with Reported Sales/Ebitda growth of 15.4%/66% y-o-y led by 300 bps Ebitda margin expansion to 9.7%. Comparable sales growth was 18% y-o-y; (iii) Hotels business remained severely impacted, with reported sales down 81% y-o-y;

(iv) Agri business (segment sales/Ebit up c12.8%/2.7% y-o-y, respectively) benefited from trading opportunities while Paperboards, Paper and Packaging was weak due to subdued demand.

Investment case for ITCITC trades at an FY22e PE of 13.9x, a deep discount to peers’ average of 40x. The key reason is that earnings growth in cigarettes has fallen (even without COVID-19) to mid-single digits and comes with regulatory risks and ESG concerns. How should one make sense of the value?

Our analysis suggests that current valuation now builds in zero earnings growth forever for the Cigarettes business and values FMCG-Others business at c3.5x FY21e EV/Sales. We think both are conservative. But the key questions are what can unlock value and what could the potential catalysts be? It is clear cigarette has ceased to be the high-growth business it once was.

Hence a large part of the share’s attractiveness lies in the size of the dividend pay-out (which has recently risen) that ITC can make sustainable. The FMCG-Others business is now large scale, offers attractive growth and we think continued margin expansion will be a key catalyst for multiple re-rating for this business.

Finally, ITC as a large conglomerate is always subject to investor debate as to whether it might ever consider reorganising its business structure to unlock value. We make modest changes in our estimates, which leads to a new TP of Rs 230, and we retain Buy rating.