ITC margins to drop 100bps due to excise hike: ICICI Direct

Cigarette major ITC today reported numbers which were tad higher than street estimates, with net profit rising 20% year on year and a 15% growth in volumes. However, going forward, Sanjay Manyal of ICICI Direct says weak monsoon could adversely impact the company.

“We understand there will be some impact of monsoon as it has been fairly weak, but that will be restricted to one-two quarters and not more than that,” he said. Despite this, Manyal says ITC will record around 18% earnings growth for the year FY13, along with a 1.8% growth in volumes in the cigarette space. “Because of the ban on gutka and paan by almost six states, we believe that some demand is going to shift from these tobacco products to cigarettes and that will result in some marginal growth in the cigarette volume,” he explained. However, he sees margin growth to dip around 100 basis points year on year due to the excise duty hike announced in the Budget this year. “Until and unless the company takes another 10% price hike on cigarettes, the overall full year business margins should come down a bit,” he said. ICICI Direct does not see the stock move sharply due to these results, and sticks to their target price of Rs 270. Below is an edited transcript of his interview with Latha Venkatesh and Reema Tendulkar. Q: How have you read ITC’s numbers, the cigarette business performance and any other details that you have? A: As far as cigarette business performance is concerned, we are expecting almost flat kind of a volume growth this quarter at least. As for earnings, it has again shown earning growth is in line with our estimates. FMCG losses have come down to Rs 38 crore from the previous Rs 76 crore which is again a positive. That it has seen a 20% earnings growth which is very much in line with our estimates. Q: Have the margins surprised you positively, not just cigarette but the overall margins, coming at 34.7% up from 32.7% that we had in the same quarter a year ago? A: No. Last year the company has taken two price increases despite no excise duty hike. This year they have taken a price hike immediately after the excise hike, so margin improvement on year on year basis was expected. On a full year basis, by the end of the year you will see a dip in overall margins. Q: How do you reckon the stock will move from hereon on the back of these numbers because it is trading at very high valuations? A: It is trading at very high valuation, but you need to understand that ITC has always traded at high valuation and this is in line with our estimate. We do not see much steep movement in the stock price. Our target price is Rs 270 and we continue to remain positive on that. Q: So you will not change even your EPS estimates or your revenue target on the back of these numbers? A: No we will not change our estimates. Q: Inspite of it you think margins we will erode? A: Until and unless the company takes another 10% price hike on cigarettes, the overall full year business margins should come down a bit Q: A bit as in you would expect it to be 100 basis point fall? A: Around 100 basis points. Q: What about the other broader market FMCG stocks like Dabur, which came out with a healthy set of numbers? Give us a sense in terms of any picks that you have from these other broader market midcaps, non-Nifty FMCG companies? A: Dabur has shown 12% kind of volume growth, though margins have dipped by 200 bps compared to the previous year. We have to understand that for Dabur, this kind of volume growth may not be sustainable because of weak monsoon in the second and third quarter. But on an overall basis, these companies are going to do fairly well on full year basis. So if 12% volume growth is there in Dabur kind of companies, then that’s again one of our top picks. _PAGEBREAK_ Q: What are you expecting from Indian Tobacco Company (ITC)? A: We are expecting 20% revenue growth and in terms of volumes in cigarettes we expect flat volumes. For the entire year though, we believe that there will be some marginal volume growth in cigarettes despite the steep price in excise duty. As far as FMCG business is concerned, we understand that revenues should grow around 20-25% plus, which is a continuous sustainable revenue growth. Losses should further come down from the previous year, in line with losses falling continuously since the past three quarters. In terms of margin, we expect margin to come down because of the steep excise duty hike of around 20% in cigarettes. But the price increase the company has taken is around 10%, so we believe margins will probably dip a bit. Q: What are you penciling in for volume growth on the cigarette front, what you are expecting in terms of price growth and hence what will the numbers be on the margin? A: As far as cigarette volumes are concerned, what we are factoring in to the full year is 1.8% kind of a volume growth despite the steep hike in excise. One of the reasons for that is the ban on gutka and paan by almost six states. We believe that some demand is going to shift from these tobacco products to cigarettes and that will result in some marginal growth in the cigarette volume. As far as price hike is concerned company has already taken 10% price hike immediately after the budget. They probably have to take another 10% price hike in the second half of the year to sustain the margins of the previous year. We are expecting almost 35% margin in this quarter. Q: In that case, what are you expecting by way of earnings growth in the current year for ITC? A: We are expecting 18% kind of earning growth. Q: ITC is very close to its 52 week high of around Rs 260. Give us a sense in terms of how much more upside would you assume on the stock price if in case the numbers do surprise on the positive side? A: If the FMCG business starts posting profits and breaking even, then it will be one of the biggest surprises. We assume that on a full year basis they will not be able to post profit and the FMCG business they will only breakeven by FY14 on a full year basis. But if that comes, then it would be a surprise. If also in this quarter there is a volume growth in cigarettes then that will also be a surprise. We have a target price of Rs 270 on ITC. Q: Do you think the shadows of lower consumption are going to impact ITC or will FMCG continue to be outperforming as a sector in the rest of 2012? A: We understand there will be some impact of monsoon as it has been fairly weak, but that will be restricted to one-two quarters and not more than that. If you see the HUL results, the volume growth is there and simultaneously margin improvement is there despite the fact they have taken increase in advertisement expenditure. We have seen uptrading from the states which are growing by more than 10%, like Bihar, Uttar Pradesh or the smaller states, and that’s one of the reasons why there is a sustainable volume growth in HUL’s numbers. Hindustan Unilever takes almost 40% kind of revenue from the rural India and that is one of the reasons that they have sustained that kind of volume growth.