Muted volumes not the new normal
* ITC’s 3QFY15 performance was below our expectations. Sales grew 2.5% YoY to INR89.4b (our estimate: INR96.9b), EBITDA grew 5.5% YoY to INR34.6b (our estimate: INR37b), and adjusted PAT increased 10.5% YoY to INR26.4b (our estimate: INR27.5b).
* Cigarette volumes collapsed 12-13% to a multi-year low:
Segment EBIT grew 8.8% (lowest since 1QFY09) and margin expanded 520bp to 69.7%. The full impact of excise duty hike (taken in July 2014) coupled with VAT increase in certain states (Tamil Nadu, Kerala and Assam) impacted cigarette volumes. Three years of consecutive 15%+ excise duty increase has resulted in aggressive price hikes by ITC, which has kept cigarette volumes muted since FY12.
* Non-Cigarette FMCG posted 11.4% sales growth:
Segment volumes grew 7-8% and EBIT was INR115m. Snacks, noodles and personal care outperformed, while biscuits remained sluggish. We expect ITC to take price cuts in its FMCG portfolio to pass on the benefits of input cost correction.
* Agri revenues declined 10.6% YoY, impacted by absence of trading in soya and margins expanded 340bp due to improvement in mix (better realization from leaf tobacco). Hotels segment posted weak 4.7% YoY growth but margins contracted 1100bp due to lack of operating leverage and higher depreciation. Paper segment revenue declined 4.7%, led by slowdown in FMCG and cigarettes while segment EBIT declined 7.7% and margins contracted 60bp to 17.8%.
* Maintain BUY:
We have cut our earnings estimates for FY15-17 by 3-4% and model 7.5% cigarette volume decline in FY15. The double digit volume decline is an aberration in our view and does not set a new normal. At 25x FY16E and 21.6x FY17E EPS, ITC trades at a discount of ~30% to the sector average. While we remain bullish on ITC given the relatively attractive valuations, we expect (a) recent policy action (ban on loose sticks, etc), and (b) speculation on potential excise duty increase in the budget to cap near term outperformance. We maintain Buy with a target price of INR420 (26x FY16E EPS, 20% discount to HUVR).
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