Maintain ‘buy’ on ITC with unchanged FV at Rs 260

FY2020 Ebitda growth print (+4% y-o-y) was impacted by higher taxation and Covid outbreak. FCF grew 30% to Rs 117 billion led by reduction in W-cap and tax rate cut. FMCG portfolio augmentation with steady margin expansion continued. Inexpensive valuation (6% dividend yield; cigarettes business trading at 7X PE at CMP) and promising prospects in FMCG (LT growth potential with margin expansion) underpin our positive stance. Maintain ‘buy’ with unchanged SoTP-based FV of Rs 260.

ITC reported 3.5% growth in FY2020 following a healthy 11% growth in FY2019. PAT growth was healthy at 14.5%, added by lower ETR. Ebitda growth was weak across segments — cigarettes (+2.2%), FMCG (+32.8%; off a low base), hotels (+12%), agri (+2%) and paperboards (+6.2%). Ebitda growth was weak on the back of cigarettes business facing double-whammy of higher taxation (in February 2020) and impact of lockdown (9M/4Q volumes: +2.7/-11% yoy), weak 5% (LFL) revenue growth in FMCG due to overall slowdown and Covid impact; margin expansion continued (off low base), weak demand in hotels in 1H; some pick-up in 2H, partly led by GST rate cut, was short-lived due to Covid impact from February 2020, and lower realisations and weak underlying demand in paperboards.

ITC’s FCF increased 30% y-o-y in FY2020 to Rs 117 billion led by reduction in W-cap and lower ETR (FCF was down 11% in FY2019 mainly due to W-cap increase). FCF/Ebitda for FY2020 stood at 65.3%, highest in last many years. In the past six years, FCF CAGR was a healthy 17.7%. RoE expanded 60 bps to 23.3%, again due to lower ETR, even as asset turnover was lower. RoCE declined to 25% (FY2019: 27%) due to weak operating profit growth. ITC has undergone time correction/de-rating over the past eight years notwithstanding EPS/FCF CAGR of 10%/15% (FY2012-20). We believe concerns around taxation in view of stretched government finances and rising focus on ESG-compliant investment are more-than-adequately priced in.

The stock offers a good combination of inexpensive valuations (13X Sep 2022E PE), healthy dividend yield (6%) and promise of solid LT growth in FMCG. We do not see any structural negative emerge for ITC from the ongoing pandemic.

2QFY21E outlook—cigarette volume dipped a bit in July and Aug (after normative levels in June) due to local lockdowns but have picked up again in Sep, FMCG core portfolio (75% of FMCG ex-stationery; grew 34% in 1Q) is tracking well except for slight moderation in biscuits. Discretionary/OOH portfolio is witnessing some recovery (lower salience of juices/deos in 2Q would also help optically). Stationery sales continue to be depressed as schools are shut, and hotels—topline weakness continues but losses likely to moderate as compared to 1Q levels.