Buy ITC; target of Rs 400: Motilal Oswal

ITC’s operating performance for 4QFY16 was better than expected, with net sales up 9.4% YoY to INR 101.7b (vs. our est. of INR 99.2b) and EBITDA margin coming in at 36.3% (vs. our est. of 35.6%). EBITDA was up 11.7% YoY to INR 36.9b (vs. our est. of INR 35.3b). PBT at INR 38.3b was also ahead of our estimate of INR 36b, though a higher than expected tax rate at 34.9% (vs. our estimate of 30.1%) resulted in PAT at INR 25b, up 3.9% YoY, coming in line with our est. Cigarette volume is likely to have remained flat YoY (highest levels since 4QFY13 and better than our expected decline of 3%), aided by a higher growth in the sub 65mm segment (share in the high teens in overall volume, in our view), benign base (reported volume decline of 13% in 4QFY15) and lower price increases off late. There appears to have been no gains from inventory loading in 4QFY16, unlike our earlier expectation. Cigarette revenue and EBIT grew by 10.2% YoY and 11.5% YoY, respectively while cigarette EBIT margin expanded by 80bp YoY (despite impact of mix). The company’s cigarette volume over the last three years has been impacted by consecutive excise duty/VAT increases and regulatory headwinds, though the worst impact on volume appears to be over. Non-cigarette FMCG business recorded a sales growth of 5.4% YoY, mainly due to a weak demand environment, deflation in the personal care segment, and sales of the stationery segment being shifted to 1QFY17 on account of change of season. The segment reported EBIT of INR708m while its EBIT margin expanded by 70bp YoY to 7.1%. Revenue of the agri business increased by 26.5% YoY, though its margin declined by 190bp YoY to 9.7%, as the absence of commodity exports in the base quarter had resulted in elevated margins.

The company’s dividend pay-out ratio for FY16 stood at 85%, marking the decade’s highest level. We have kept our FY17/18E estimates unchanged. At 23.7x FY17E and 20.7x FY18E EPS, ITC trades at a significant discount to the sector average. The volume growth outlook for the crucial cigarette segment (86% of FY16 EBIT) appears to be improving over the past two quarters, and we believe that the worst is now behind for the segment. Most of the negatives (including the onset of 85% pictorial warnings) are now factored into the stock price. Hence, we are raising our target P/E to 25x and maintain Buy with a revised TP of INR 400 from INR 370 earlier, up by 21%.For all recommendations, click here Disclaimer: