Risk factors to watch: Acceleration in the cigarettes business downtrading; review and increase in ad valorem duty by subsequent GST Council meetings and delay in rural demand recovery
As a weekly tactical pick, we recommend ITC. The stock has sharply corrected in the last one month and currently trades at a steep discount (22 times FY21 estimated earnings) to the earnings multiple of the largecap FMCG sector (around 38 times).
This is in contrast to improving fundamentals of most businesses ITC is exposed to and the current risk-reward appears favourable. With the GST review decisions relegated to the GST Council and improving business mix towards FMCG/food processing industry, we believe the Budget has potentially more to offer.
In addition to the attractive valuation, following factors makes us constructive on the stock:
In the recent quarterly result, cigarettes volume growth (7-8 percent year-on-year) were better-than-anticipated and appear to benefit from stable taxation regime for the last 23 months.
The thesis of broadening growth levers for ITC is unfolding as expected. Few of ITC’s other businesses have witnessed encouraging growth traction in recent times: volume growth in the FMCG business (other than cigarettes) and growth outlook in the hotel and paper business.
We are enthused about the operating leverage playing out in the FMCG business in particular. In FY19, FMCG business' EBITDA grew 51 percent. A back of the envelope calculation suggest that a normalisation of ITC’s FMCG business margin, in line with peers, could help ITC’s overall EBITDA margin to perk up about 280 bps, ceteris paribus.
Capital allocation also remains pertinent. The management continues to deploy healthy operating cash flows (Rs 12,651 crore in FY19), mainly from the cigarettes business for investment across businesses (Rs 2,767 crore) in FY19. Of this, almost 50 percent of the investment has gone to the FMCG business.
In fact, the management has kept an investment outlay of Rs 25,000 crore, which among others, targets for creation of Integrated Consumer Goods Manufacturing & Logistics facilities (ICMLs) for its FMCG businesses and to strengthen distribution and the agri-backend. This makes it increasingly a beneficiary of policy measures taken for food processing industry. And in this context, the Budget has potentially more to offer to the stock.
Risk factors to watch: Acceleration in the cigarettes business downtrading; review and increase in ad valorem duty by subsequent GST Council meetings and delay in rural demand recovery.(Disclaimer: Moneycontrol Research analysts do not hold positions in the companies discussed here)