Madhuchanda Dey
Moneycontrol Research
ITC reported single-digit earnings growth in a quarter marked by GST pangs and regulatory headwinds. The recent cess on cigarettes under GST appears to have dampened sentiment for the stock somewhat. However, we believe GST minimises the vagaries of state-level taxations, and the discount of ITC to the FMCG universe is an opportunity for long-term investors.
Quarter at a glance
ITC’s gross revenues rose 4 percent, and operating margin improved over the previous as well as the corresponding quarter. The double-digit growth in other income and muted increase in interest and depreciation expenses aided the 7 percent growth in profitability.
The gainers and losers
Cigarette
The value growth in the cigarette business was 6.6 percent during the quarter. Volume sales rose 1 percent against the Street expectation of a decline or negative volume growth. The growth in profitability was higher at 9 percent due to margin expansion.
The management estimates the combined impact of increase in excise duty, and the recent GST cess to result in an additional 20 percent-plus tax burden. The company recently raised prices of select brands. The impact of higher taxes on the cigarette business’ margin will be clearer in the ensuing quarter and would be watched closely as it contributes the lion’s share (above 85 percent) to the profitability of the company.
FMCG
ITC is gradually building up a meaningful FMCG business that grew 9 percent in a subdued demand environment during the quarter. Revenue growth was driven primarily by the branded packaged foods, personal care and stationery products. But growth was tempered by the restructuring of the retail divisions, an early 'end of season sale' and heavy discounting triggered by GST transition.
Profitability was impacted by higher input costs (wheat, oil, soap noodles, sugar), sustained investment in brand building and gestation costs of new categories viz. juices, dairy, chocolates, and health & hygiene segment in the Personal Care Products business.
In the hotels business, the over 6 percent growth in revenue was driven by improvement in average room rate, and higher food & beverages sales. The year-on-year improvement in profitability could be attributed to operating leverage and costs management. However, certain properties like ITC Grand Chola, Chennai lost out on account of the ban on sale of liquor at outlets on the edge of highways. The gestation costs of the recently commissioned ITC Grand Bharat, Gurgaon also had an impact.
Agri Business
Revenue and profitability of the agri business were under pressure due to lower crop output, the adverse quality of the Andhra leaf tobacco crop due to drought in 2016, and limited trading opportunities in other agri-commodities. However, this business for ITC provides a critical linkage to rural India and supports sourcing of tobacco for the cigarette business and agri raw materials for the food business.
Paperboards, Paper & Packaging
The performance of the paperboards, paper & packaging segment was impacted due to sluggish demand conditions prevailing in the FMCG and cigarette industries. In addition, de-stocking of FMCG and pharma products in trade channels ahead of the transition to GST, and the ban on sale of liquor from outlets near highways weighed on sales. Profitability, however, improved on the back of benign input prices and richer product mix.
The way ahead
While GST has impacted the company in more than one ways in the quarter, it continues to be a long-term positive for an organised player like ITC. India today is the 4th largest market for illegal cigarettes in the world. It is estimated that almost 68 percent of the tobacco consumed in the country remains outside the tax net on account of evasion.
Although legal cigarettes account for only about 11 percent of total tobacco consumption in the country, they contribute more than 87 percent of tax revenue from the tobacco sector. The other types of tobacco products contribute barely 13 percent of tax revenue despite accounting for 89 percent of total tobacco consumption. We expect GST to hurt the unorganised sector more than ITC where the rates have only gone up incrementally.
At 30 times FY18 projected earnings ITC offers quality and value for long term investors.
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