ITC Ltd.

Q4FY11 Result Update

HDFC Sec Scrip code ITCLTDEQNR Industry FMCG CMP (Rs.) 187.3 Recommended Action Buy on dips

CMP: Rs. 187.3

May 25, 2011
Entry Price Point (Rs.) 171 Target (Rs.) 197 Time Horizon 3 months

ITC recently came out with Q4FY11 results. We present an update on the same. Q4FY11 Results Review ITC reported good set of numbers for Q4FY11 (Y-o-Y). Net sales increased by 15.5% Y-o-Y to Rs. 58.4 bn as against Rs. 50.5 bn in Q4FY10 on account of good Y-o-Y performance across all its segments. The operating profit grew by 16.2%, supported by relatively lower rise in the employee cost (up 9% Y-o-Y). The total expenditure as a % to net sales declined from 42.7% in Q4FY10 to 42.1%. The material cost rose 13.9% Y-o-Y, while the other expenses increased by 19.2%. Y-o-Y. OPM improved by 18 bps Y-o-Y to 30.7%, supported by higher margins in cigarettes, hotels and agri-business business. Relatively lower growth in the depreciation cost (up 6.7% Y-o-Y), decline in the interest cost (down 53.1% Y-o-Y) & higher other income (up 52.2% Y-o-Y) boosted the PAT, which rose 24.6%. PAT margins improved by 161 bps Y-o-Y to 22%. EPS for the quarter stood at Rs. 1.7 vs. Rs. 1.3 in Q4FY10. All the businesses did well on both revenue & EBIT front (Y-o-Y). Cigarettes business net revenues increased by 12.8% Y-o-Y (which was decent, but a bit lower than what we had estimated due to 2% drop in the cigarette volumes as compared to our estimates of 3-4% growth in the volumes), while the net sales of Paper & Packaging and Agri business increased by 14.2% & 9.5% respectively (Y-o-Y). Even the new FMCG & Hotels segment reported robust Y-o-Y growth of 16.9% & 17.2% respectively. Profitability-wise Cigarettes, Agri Business and Hotels EBIT grew by 17.5%, 43.1% & 27.3% Y-o-Y respectively with an improvement in their respective margins. Paper & Packaging EBIT grew by 14.7%. Also the non-cigarettes FMCG business managed to lower its losses on a Y-o-Y basis. On a sequential basis, the results were decent on the revenue front but subdued on the profitability front. Net sales grew by 7%, while operating profit & PAT declined by 9.1% & 7.7% respectively over Q3FY11. OPM & PATM fell sharply by 545 bps Y-o-Y & 51 bps Q-o-Q from 36.1% & 25.5% respectively. Cigarettes disappointed sequentially as the business revenues (gross) fell by 2.4%, while the net revenue fell marginally by 0.1%. Even Agri business reported marginal growth of 1.4% Q-o-Q in revenues. The revenue growth of Paper & Packaging and Hotels business (net) was much better at 4.5% & 6.6% Q-o-Q respectively, while the New FMCG Business reported robust growth of 19.1% in its turnover. On the profit front, Hotels business did well, reported growth of 12.4% in its EBIT, while Paper & Packaging EBIT grew marginally by 1.2% Q-o-Q. Further, new FMCG business managed to reduce its losses on Q-o-Q basis. However, Cigarettes & Agri business disappointed, as their EBIT declined by 4.1% & 29.3% Q-o-Q respectively. Quarterly Financials: Particulars Q4FY11 Q4FY10 VAR [%] Q3FY11 VAR [%] (Rs. in Million) Remarks Y-o-Y growth driven by strong performance by all its businesses. However, on a Q-o-Q basis Cigarettes business disappointed, reporting de-growth in revenues, while Agri 7.0 business reported a marginal growth in revenues. However, other businesses did well. Total expenditure as a % to net sales declined by 18 bps Y-o-Y, but rose sharply by 545 16.1 bps Q-o-Q to 69.3% in Q4FY11. 2.5 65.3 0.6 13.1 OPM improved by 18 bps Y-o-Y to 30.7%, supported by higher margins (net) across all the segments, mainly cigarettes, hotels and agri-business business. Even the FMCG -9.1 business managed to reduce its losses, which aided the margins despite high input cost &
1

Net Sales Total Expenditure Raw Material Consumed Stock Adjustment Finished Goods Purchased Employee Expenses Other Expenses

58362.6 40471.5 18621.6 1153.7 4800.8 2789.7 13105.7

50537.9 35135.8 15382.6 2028.3 4170.5 2558.4 10996

15.5 15.2 21.1 -43.1 15.1 9.0 19.2

54534.9 34844.5 18161.1 -587.2 2904.5 2773.4 11592.7

Operating Profit

17891.1

15402.1

16.2

19690.4

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Other Income PBIDT Interest PBDT Depreciation PBT Tax (incl. FBT & DT) PAT EPS Equity Face Value OPM (%) PATM (%) Segmental Results:

2258.9 20150.0 140.1 20009.9 1642.2 18367.7 5552.9 12814.8 1.7 7738.1 1 30.7 22.0

1483.8 16885.9 299 16586.9 1538.6 15048.3 4765.7 10282.6 1.3 7636.4 1 30.5 20.4

52.2 19.3 -53.1 20.6 6.7 22.1 16.5 24.6 23.0 1.3 0.0 0.6 7.9

2532.9 22223.3 229.6 21993.7 1681 20312.7 6421.9 13890.8 1.8 7705.9 1.0 36.1 25.5

tough competitive scenario. Relatively lower growth in the employee cost helped in margin improvement. Also, the material cost grew lower than in line with sales growth. However, higher other expenses restricted further margin expansion. Y-o-Y rise in other income was due to higher treasury yields & increase in miscellaneous -10.8 income. -9.3 -39.0 -9.0 -2.3 -9.6 The effective tax rate on PBT declined by 144 bps Y-o-Y & 139 bps Q-o-Q to 30.2% due -13.5 to beneficial impact of deferred tax. Higher other income, relatively lower growth in depreciation cost, decline in the interest -7.7 expense and lower effective tax rate on PBT led to robust Y-o-Y PAT growth. -8.1 0.4 0.0 -15.1 -13.8
(Source: Company, HDFC Sec)

(Rs. in Million) Particulars Revenue (Gross) FMCG - cigarettes FMCG - others Paperboards, paper & packaging 51111.3 13148.2 9614.8 45168 11252.7 8360.1 13.2 16.8 15.0 52362.6 11041.9 9166.7 -2.4 19.1 4.9 Robust Y-o-Y revenue growth on the back of higher soya sales & pick-up in the leaf tobacco exports business (though the leaf tobacco volumes were low during the quarter). The business managed to sustain strong growth despite increase in supply of global tobacco. ITC is setting up a new tobacco facility in Mysore, which is expected to go on 1.4 stream from FY12. This would help in reducing logistics costs for procurement and exports. Strong Y-o-Y sales growth driven by improvement in ARRs & occupancy rates. With the Chennai property (close to 600 rooms) expected to commence in Q2/Q3FY12, accelerating occupancy rates & improving ARRs, we expect the performance of the Hotels segment to be robust in FY12. Further, Kolkata property (~500 rooms) is also on course to be launched 6.9 in FY13/14E, which is expected to drive the segment revenues going forward. 1.9 -15.5
2

Q4FY11

Q4FY10 VAR [%] Q3FY11 VAR [%]

Agri-business

10818.3

9880.9

9.5

10667.4

Hotels Total Less: Inter segment Revenue

3243.1 87935.7 5594.8

2742.8 77404.5 5817.3

18.2 13.6 -3.8

3032.5 86271.1 6618.4

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Gross Sales Revenue (Net)

82340.9

71587.2

15.0

79652.7

3.4

FMCG Cigarettes

27673.4

24529.5

12.8

27726

FMCG Others Paper Boards, Paper & Packaging Agri Business Hotels Total Less: Inter Segment Revenue Net sales/income from Operations Segment EBIT FMCG Cigarettes

13125.1 9169.6 10818.3 3003.3 63789.7 -5427.1 58362.6

11227 8029.9 9880.9 2562.1 56229.4 -5691.5 50537.9

16.9 14.2 9.5 17.2 13.4 15.5

11021.3 8773.3 10667.4 2816.3 61004.3 -6469.4 54534.9

Y-o-Y revenue growth in cigarettes was a bit lower than what we had projected. This was mainly because of 2% dip in the cigarettes volume attributed to pipeline correction (inventory push in Q3FY11 due to pictoral warning issue arising in Q3FY11) & higher base of Q4FY10 (8.5% growth in volumes in Q4FY10). However, the consumer demand continued to remain strong and the volume pick up is on track as per the management. The segment revenue growth was entirely driven by price hikes undertaken (~15-16% -0.2 price hikes undertaken on a weighted average basis). Revenue growth of other FMCG business, though robust, was lower as compared to 9MFY11 growth of 26%. This could be due to high base of Q4FY10 & lower growth in the safety matches division. Strong growth in Sunfeast biscuits (up ~20%, driven by improvement in the product mix - higher sales of value added variants of cookies & creams) & Bingo (up ~25%) drove the overall foods segment growth. The company re-launched Dark Fantasy during the quarter along with introducing Dark Fantasy Chocofill biscuits in the premium category. In the personal care segment, which continued to witness healthy traction, the launch of fairness cream was a success, as the brand gained healthy market share in key markets, where it was launched. Further, the company has managed to sustain its soaps market share at 6% and expects to have a strong grip in the shampoo market as well with new launches going 19.1 forward. The current market share of the company in shampoo segment is ~2-3%. We feel that the segment growth is expected to remain in low double digits in FY12 & 4.5 accelerate post the commissioning of 1 lac TPA new paperboard mill (likely in H2FY12) 1.4 6.6 4.6 7.0

14706

12512.2

17.5

15329.5

FMCG Others

-678.4

-786.90

-736

-4.1 Cigarette EBIT margins (gross) improved by 107 bps Y-o-Y to 28.8%, driven by price hikes. FMCG others witnessed a reduction in the losses both on Y-o-Y & Q-o-Q basis, which was impressive, considering high input cost & tough competitive scenario. This improvement was due to favourable product mix, higher realisations & a combination of smart sourcing, increased internal efficiencies & cost saving across supply chain. Strong profitability in the biscuits segment has helped the packaged foods business to breakeven as a whole during FY11. While Staples, Confectionery, Biscuits, all are profitable, bingo is close to getting breakeven. Besides the foods business, personal
3

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Paper Boards, Paper & Packaging

1937.2

1688.20

14.7

1914.2

Agri Business Hotels Total Interest Other un-allocable expenditure net off un-allocable income Total Profit Before Tax Gross EBITM (%) FMCG - cigarettes FMCG - others Paperboards, paper & packaging Agri-business Hotels Total Net EBITM (%) FMCG - cigarettes FMCG - others Paperboards, paper & packaging Agri-business Hotels Total Capital Employed FMCG Cigarettes FMCG Others Paper Boards, Paper & Packaging

997.5 995.7 -140.1 549.8 18367.7

697.00 782.00 -299 454.4 15047.9

43.1 27.3 20.6 21.0 22.1

1410.8 886 18804.5 -229.6 1737.8 20312.7

care & lifestyle retailing businesses are still into losses. The management expects the overall segment losses to reduce further by 14-15% during FY12. The segment PBIT margin fell both on Y-o-Y & Q-o-Q basis. The commissioning of 1 lac TPA paperboard line will boost operating performance from FY13 onwards. Expected 1.2 increase in the contribution of value added paperboard could lead to margin expansion. Strong Y-o-Y PBIT growth (substantially higher than the sales growth) & substantial improvement in PBIT margins due to higher realisations of Leaf tobacco & Soya. The management expects the segment margins to remain steady in FY12 due to more focus on -29.3 high profitability products. Strong EBIT growth & improvement in margins on both Y-o-Y & Q-o-Q basis was on the 12.4 back of improvement in ARRs & occupancy levels (in high 60s). -4.5 -68.4 -9.6

17958.00 14892.50

28.8 -5.2 20.1 9.2 30.7 20.4

27.7 107 bps -7.0 20.2 -5 bps

29.3 -6.7 20.9 29.2

-50 bps -73 bps 149 bps

7.1 217 bps 28.5 219 bps 19.2 118 bps

13.2 -400 bps 21.8 -138 bps

53.1 -5.2 21.1 9.2 33.2 28.2

51.0 213 bps -7.0 21.0 10 bps

55.3 -6.7 21.8 13.2 31.5 30.8

-215 bps -69 bps -400 bps 169 bps -267 bps

7.1 217 bps 30.5 263 bps 26.5 167 bps

30621.4 18971.2 37701.2

29607.9 16663.5 37112.7

3.4 13.8 1.6

33941.9 17191.6 37340.1

-9.8 10.4 1.0

4

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Agri Business Hotels Total Capital Employed Other Key highlights:

15616.5 27284.4

15795.6 24573.5

-1.1 11.0

14794.8 26003.5

5.6 4.9 0.7

(Source: Company, HDFC Sec)

130194.7 123753.2

5.2 129271.9

ITC has declared dividend of Rs. 4.45 per share (which includes one- time dividend of Rs. 1.65 per share). This indicates a high payout ratio of 80% for FY11 (in FY10, the dividend payout ratio stood at 110%). This is higher than the average payout ratio over the past few years, which stood at around 47%. Conclusion & Recommendation: While ITC reported strong set of numbers for FY11, it was marginally below what we had projected. The net sales grew by 16.6% to Rs. 211.68 bn [vs. our estimated net sales of Rs. 211.94 bn], while the operating profit & PAT increased by 17.8% & 22.8% to Rs. 71.53 bn & Rs. 49.88 bn respectively [vs. our estimated operating & net profit of Rs. 73.54 bn & Rs. 50.86 bn respectively]. This could be mainly due to slower than expected growth (though decent) reported by cigarettes segment in Q4FY11, which reported 2% decline in the volumes as compared to our projection of 3-4% growth in the volumes (for Q4FY11). However, the management has indicated that the dip in volumes was mainly due to pipeline correction (inventory push in Q3FY11 due to pictoral warning issue arising in Q3FY11) & higher base of Q4FY10 (8.5% growth in volumes in Q4FY10). However, the consumer demand continued to remain strong and the management expects a strong bounce back in volume growth in FY12. While the NIL hike in excise duty on cigarettes in Union Budget FY11-12 was a positive surprise, there could be increase in the VAT rate by the states during FY12. While VAT rate has already been increased by a few states like Gujarat (from 20% to 25%), Rajasthan (from 20% to 40%), Bihar (from 12.5% to 13.5%) & HP (from 13.75% to 16%), Kerala, Tamil Nadu & West Bengal, which are key states for ITC (as they account for close to 30% of cigarette sales) are yet to present the state budget. However, looking at the past resilience, which the business has shown despite high tax burden & regulatory hurdles, we feel that ITC is well placed to pass on the increase in duties without much deviation in EBIT growth. While the GST implementation has been on a backburner and has been postponed to FY12, as and when it is implemented, it could further reduce the uncertainty on cigarette volumes, as the taxes like VAT & sales tax will combine into a uniform GST. Marlboros launch has not yet impacted ITCs competitive positioning. With strong brands in its portfolio, new launches and extensive distribution network, the segment is expected to report robust growth going forward. We expect good volume growth in cigarettes (5-7%) in FY12 (in FY11, cigarettes volumes declined by about 1.5%). The non-cigarette FMCG business reported robust growth in FY11 (net sales up 23.1%), led by good performance by all its segments like Branded Packaged Foods, Personal Care and Education & Paper Stationery. The company has also managed to reduce the segment losses from Rs. 3495.1 mn in FY10 to Rs. 2975.9 mn in FY11. Going forward, increasing contribution of the packaged foods business (which is expected to deliver strong revenue growth on the back of rise in the investment toward enhancing the manufacturing facility and increase in the distribution infrastructure) and the strong growth in the personal care and stationery businesses, we expect the segment to continue to report strong revenue growth and reduce its losses further in the coming quarters on the back of improved revenue mix. The management expects the segment losses to reduce further by 14-15% during FY12. The segment could break even by FY13. Hotels business has started to witness a turnaround over the last few quarters & with the commissioning of new properties (600-room Chennai property likely to commence in Q2/Q3 of FY12E; 500 room hotel in Kolkata likely to be commissioned in FY13/FY14E), buoyancy in the domestic & foreign tourism, gradual improvement in ARRs & occupancy levels, we expect the segment to do well on the revenue & profit front in FY12 (though the recovery is not expected to be very sharp) and theron. As regards the Agri business, while the revenue growth could continue to remain steady, margin sustainability / improvement could be an issue in the coming quarters. With a shift in managements focus to higher profitability products, we expect the segment margins to stabilise. While the performance of Paper Board & Packaging business has not been impressive, the same (revenue & profits) is expected to improve due to replenishment of cigarette packaging industry post the commencement of new paperboard unit, which is expected to go on stream in H2FY12. The company has plans to double the divisions capacity over the next 5 years. Favourable product mix & value enhancement through in-house pulp production facility could improve the segment margins going forward. We feel that ITC could surpass our financial projections for FY12. Hence we are revising our net sales & PAT estimates up by 1.4% & 3.1% respectively for FY12 to account for robust growth in cigarettes, recovery in hotels segment & reducing losses of non-cigarette FMCG losses. EPS is expected to be Rs. 7.6 vs. our original estimates of Rs. 7.4. In our Q3FY11 result update dated Feb 04, 2011, we stated that the stock could trade in the Rs. 148-170 band for the next quarter. Thereafter the stock touched a low of Rs. 150 on Feb 24, 2011 & subsequently touched a high of Rs. 194.8 on April 28, 2011. At the CMP of Rs. 187.3, the stock trades at 24.7xFY12E Revised EPS, which is at a discount to other

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established FMCG players like Nestle, Dabur, HUL, etc. For margin of safety & better returns, we recommend investors to buy this scrip on dips at the price of Rs. 171 (22.5xFY12E EPS) for a price target of Rs. 197 (26xFY12E EPS) over the next quarter. Key concerns to watch out going forward (which could cap the upside in the stock

price) are slower recovery (than expected) in the hotels segment, delay in the ramp up of new facilities (in Hotels & Paper and Packaging segment), slower pace of reduction in losses in the non-cigarettes FMCG business due to increasing competition and expected investments in new launches & re-launches (which could infact increase the losses in FY12), competition from Philip Morris (who could adopt aggressive marketing strategy to promote its premium cigarette brand Marlboro).

Financial Estimations:
(Rs. in Million) Particulars Net Sales Operating Profit Net Profit EPS (Rs.) OPM (%) PATM (%) PE
*Quick Estimates Act - Actual; OE - Original Estimates; RE - Revised Estimates

FY09 156119.2 48585.4 32635.9 8.6 31.1 21.2 21.8

FY10 (Act) 181531.9 60740.3 40610.0 5.3 33.5 22.4 35.2

FY11 (E) 211937.2 73542.2 50864.9 6.6 34.7 24.0 28.4

FY11 (Act) 211675.8 71534.4 49876.1 6.5 33.8 23.6 28.9

FY12 (OE) 240057.8 82819.9 56653.6 7.4 34.5 23.6 25.5

FY12 (RE) 243427.2 83982.4 58422.5 7.6 34.5 24.0 24.7

(Source: Company, HDFC Sec Estimates)

Analyst: Mehernosh Panthaki (mehernosh.panthaki@hdfcsec.com)

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