ITC Q4 review: Improving FMCG margin profile indicates operating leverage at work

Highlights: - Better-than-expected cigarette volumes; lower segmental margin underline fragile recovery - FMCG business benefits from restructuring, operating leverage and mix
- Hotels and paper businesses performance in line with sector-wide promising trend
- Growing interest in dairy business a key aspect to watch
- FMCG margin expansion holds promise for re-rating
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ITC’s Q4 FY19 operating sales grew 13.3 percent year-on-year led by double-digit topline growth for all segments.

Result snapshot Source: Company

Key positives Better-than-expected volume growth in the cigarette businesses, which constitutes 43 percent of sales, was the key positive. Volume growth is estimated to be in the 7-8 percent range and partially benefits from a stable Goods & Service Tax (GST) rates. However, operating margin were a tad weaker due to adverse product mix and higher cost of leaf tobacco.

FMCG sales (25 percent of sales) grew 10 percent YoY after excluding the impact of restructuring of lifestyle retailing and education and stationery products businesses. The management highlighted that EBITDA margin for the FMCG business is seven percent compared to 5.7 percent in Q4 FY18. Though this is still long way from the frontline FMCG benchmarks, it is fast improving. Absolute segmental EBITDA increased 31 percent YoY driven by enhanced scale and better product mix.

Hotels business (four percent of sales) saw a steady improvement in sales, benefiting from higher occupancy, increase in room rates and higher food and beverage revenue. Operations at the recently commissioned hotels -- ITC Kohenur, Hyderabad (commissioned in Q1 FY19) and ITC Grand Goa (possession granted in October last year) -- were scaled up. The company updated on the steady progress in the construction of ITC Hotels at Kolkata and Ahmedabad. Construction of ITC Royal Bengal in Kolkata is nearing completion and is expected to be commissioned in Q1 FY20.

Segmental performance Source: Company

Key negatives Overall EBITDA margin contracted 103 basis points (100 bps=1 percentage point) on account of higher cost of goods sold and employee cost offsetting moderate increase in other expenses. Segmental margin in the cigarette and hotels businesses were lower than last year, while there was a significant improvement in margin for the FMCG and paperboard businesses.

The management reiterated the observation of FMCG peers that consumption space has slowed down and there is sluggish demand in the rural areas.

Other observations In the agribusiness (16 percent of sales), the company has strengthened its milk procurement network for Aashirvaad Svasti dairy products, with significant increase in daily milk collection. In recent times, the company has expanded its milk sourcing network to Kolkata for fresh dairy products and to Punjab for meeting the requirement of dairy beverages under the brand Sunfeast Wonderz. The company has recently augmented the dairy category from milk to dairy products – curd, paneer, milkshakes and ghee.