ITC Ltd (ITC) 272. Non-cigarettes business profitability perks up. Result Update. ICICI Securities Ltd Retail Equity Research.

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1 Result Update Rating matrix Rating : Buy Target : 32 Target Period : 12 months Potential Upside : 18% What s changed? Target Unchanged EPS FY19E Changed from 8.6 to 9.9 EPS FY2E Introduced at 1.8 Rating Unchanged Quarterly performance crore Q3FY18 Q3FY17 YoY (%) Q2FY18 QoQ (%) Sales EBITDA EBITDA (%) bps bps PAT Key financials Crore FY17 FY18E FY19E FY2E Revenue 39, , , ,688.1 EBITDA 14, , ,98. 18,598.1 Net Profit 1,2.9 1, , ,155.3 EPS ( ) Valuation summary FY17 FY18E FY19E FY2E P/E Target P/E Div. Yield Mcap/Sales RoNW (%) RoCE (%) Stock data Particular Amount Market Capitalization ( Crore) 327,19.2 Total Debt (FY17) ( Crore) 18. Cash and Investments (FY17) ( Crore) 12,847.1 EV ( Crore) 314, week H/L 353 / 222 Equity capital crore Face value 1 Price performance 1M 3M 6M 12M ITC HUL Nestle India VST Industries Research Analyst Sanjay Manyal sanjay.manyal@icicisecurities.com January 22, 218 ITC Ltd (ITC) 272 Non-cigarettes business profitability perks up ITC reported net revenue growth (net of excise duty for base quarter as well as in current quarter) of 5.7% YoY to crore. Yearly numbers for cigarette segment are not comparable. FMCG & Hotels business witnessed a growth of 11.8% and 9.2% respectively. However, Agri buness & Paperboard segment saw de-growth of 8.4% and 4.2% respectively. Cigarette volume declined by 4% after the steep price hike taken by company to pass on the GST increase in July 217 Operating profit grew by 1.1% to crore as against our estimates of 365. Segment wise cigarettes, Hotels and paperboard EBIT grew by 7.8%, 29.9% and 9% respectively. FMCG segment reported a profit of 47 crore as against a loss of 19.7 crore The company reported an exceptional profit of crore ( 27 crore post-tax) with respect to the provision write back of Tamil Nadu entry tax after a favourable order by Supreme Court. With higher operating profit and an exceptional profit, Net profit grew by 16.8% YoY to 39.2 crore (I-direct estimate: crore) Cigarette volume continue to be in a declining trend Cigarette volume declined by 4% during the quarter as company has taken a price hikes after steep increase in GST increase in July 217. We estimate a 12.% price increase in cigarettes segment in FY18E. Additionally, the company continues to maintain a favourable product mix of 64 mm cigarettes (lower price point cigarette) at 35%; FMCG segment revenue grew by 16.2% YoY (on a comparable corresponding numbers), largely led by volume growth & favourable product mix. The growth can be attributed to low base of the corresponding quarter (growth of 3.4%) impacted by demonetisation. Profitability of FMCG, Hotels and paperboard business witnessed a significant improvement. The EBIT for FMCG segment was encouraging at 47 crore against loss of 19.7 crore in Q3FY17 on the back of favourable product mix (foods business is a high margin business). Hotels business EBIT increased by 29.9% to 54.8 crore on the back of higher room rates and increasing contribution of F&B. Similarly paperboard business EBIT increased by 9% on the back of benign input cost and higher volume growth. Continued investment & foray in new categories to drive packaged foods Though FMCG segment reported sluggish revenue growth at 8.% to crore in FY17, we remain upbeat of the growth of foods business as we believe that ITC would be the key beneficiary of a) demand revival, b) shift in consumption pattern (from unorganised to organised) and c) supply chain benefits post GST implementation. Moreover, ITC has successfully built the FMCG brands which have recorded strong sales growth over a short span of time, e.g. Aashirvaad (~ 35 crore), Sunfeast (~ 3 crore), Bingo (more than 1 crore). Additionally, entry into new segments like dairy (with Aashirvaad Svasti ghee), premium chocolates (Flabelle), juices (B Naturals) and Coffee (Sunbean) bodes well with the company s long term revenue target of 1 lakh crore by FY23. Thus, we remain positive on FMCG business and model revenue CAGR of 12.4% in FY17-2E. Attractively placed in terms of valuation; reiterate BUY Though we remain cautious on the cigarette s volume growth due higher tax incidence in the GST regime, however, we believe the stock is attractively placed at the current valuation. We continue to maintain our BUY rating on the stock price with the target price of 32. ICICI Securities Ltd Retail Equity Research

2 Variance analysis Q3FY18 Q3FY18E Q3FY17 YoY (%) Q2FY18 QoQ (%) Comments Net Sales 9, , , , Net sales witnessed 5.7% growth on the back of 11.8% growth in FMCG and Operating Income % growth in hotels segment. Cigarettes volume declined by 4%. Raw Material Expenses 3,581. 4, , , Employee Expenses Other operating Expenses 1, , , , EBITDA 3,94.5 3,65. 3, , Operating profit increased by 1.1% led by cigarette price hikes after excessive increase in GST in July 217 EBITDA Margin (%) bps bps Depreciation Interest Other Income PBT 4, ,22.8 3, , Tax Outgo 1, , , , PAT 3,9.2 2, , , Net profit increased by 16.8% led by higher EBITDA and exceptional income of 413 crore with respect to the provision write back of Tamil Nadu entry tax Key Metrics YoY growth (%) Cigarette Growth (%) 1.6 NA Cigarette numbers are not comparable FMCG (Others) Growth (%) FMCG segment reported a 11.8% growth however on a comparable basis, the segment grew by 16.2% Hotels Growth (%) Hotels business witnessed a increase in room rates and higher F&B revenues during the quarter Agri Business Growth (%) Agri growth impacted by shortage & poor quality of AP leaf crop Paperboards Growth (%) Change in estimates FY18E FY19E FY2E ( Crore) Old New % Change Old New % Change New Comments Sales Introduced FY2E numbers estimating 9.3% sales growth EBITDA EBITDA Margin (%) bps bps 37.6 PAT EPS ( ) Assumptions Current Earlier FY17E FY18E FY19E FY2E FY18E FY19E Cigarettes ( cr) 34,2. 36, , , , ,953. Cigarette Vol. Growth (%) Volume growth in FY18 has been impacted by excessive indirect tax increase in July 217 Cigarette Price Growth (%) FMCG - Others ( cr) 1, , , , , ,247.8 Hotels ( cr) 1, , , , , ,537.5 Agri Business ( cr) 8, , ,59.8 1, , ,59.8 Paperboards ( cr) 5, ,83.7 6,27.1 6, ,83.7 6,27.1 ICICI Securities Ltd Retail Equity Research Page 2

3 Segmental Analysis Exhibit 1: Cigarette revenues, revenue growth (YoY) Exhibit 2: Cigarette volume growth (YoY) FY14 FY15 FY16 FY17E FY18E FY19E FY2E Cigarette Revenues ( crore) Cigarette revenue Growth (%) FY14E FY15E FY16E FY17E FY18E Volume growth (%) FY19E FY2E Exhibit 3: FMCG revenues ( crore) and growth (%) Exhibit 4: FMCG EBIT ( crore) FY14 FY15 FY16 FY17 FY18E FY19E FY2E FY14 FY15 FY16 FY17 FY18E FY19E FY2E Revenues ( crore) Revenue Growth (%) EBIT ( crore) Exhibit 5: Hotel revenues ( crore) and growth (%) Exhibit 6: Paperboards revenues ( crore) and growth (%) FY14 FY FY FY FY18E 3.3 FY19E 3.6 FY2E FY14 FY15 FY16 FY17E FY18E FY19E FY2E Revenues ( crore) Revenue Growth (%) Revenues ( crore) Revenue Growth (%) ICICI Securities Ltd Retail Equity Research Page 3

4 Outlook & valuation Given steep GST rate increase in July 217, we estimate a 5% decline in cigarettes volumes in FY18E. However, we expect no further increase (or minimal changes) in GST on cigarettes by FY2E, which would curb the downfall in cigarettes volume in FY19E & FY2E. We are factoring in 1.% volume growth for both FY19E and FY2E. Further, in order to pass on the existing tax burden, we are estimating cigarette realisation growth of 12% in FY18E and further 8% each in FY19E & FY2E. Additionally, ITC s focus on growing its FMCG business (estimated to grow at a 12.4% CAGR over FY17-2E) by entering newer segments and tapping opportunity in foods segment would be a catalyst for topline growth in the long run. Taking into consideration the accounting changes under GST, we are thus estimating a net revenue and PAT CAGR of 7.1% and 8.8%, respectively over FY17-2E with EBITDA margin of 37.6% in FY2E. We are valuing the cigarettes business at 223 (PE multiple of 25x FY2E EPS), FMCG at 61 (5x MCap/sales FY2E), paperboards at 9 (6x FY2E EV/EBITDA), agri-business at 6 (3x P/BV FY19E) and hotels at 8 (2x EV/room FY2E) and also added the cash per share of 13. We believe cigarette s volume growth would remain muted due to ~22% additional tax burden in FY18E post GST implementation. However, revenue growth and profitability of FMCG business would be the key driven catalyst for the growth over the long term period. We maintain our BUY rating on the stock price with the target price of 32 per share. Exhibit 7: Sum of the parts valuation Cigarettes FMCG Paper Agri Hotels Cash per share 32 SOTP Exhibit 8: Valuations Sales Growth EPS Growth PE EV/EBITDA RoNW RoCE ( cr) (%) ( ) (%) (x) (x) (%) (%) FY FY18E FY19E FY2E ICICI Securities Ltd Retail Equity Research Page 4

5 Recommendation history vs. Consensus ( ) Jan-15 Mar-15 Jun-15 Aug-15 Nov-15 Jan-16 Mar-16 Jun-16 Aug-16 Nov-16 Jan-17 Apr-17 Jun-17 Aug-17 Price Idirect target Consensus Target Mean % Consensus with BUY Nov Jan-18 (%) Source: Bloomberg, Company, ICICIdirect.com Research Key events Date Event Dec-1 ITC shuts all its five cigarette manufacturing units awaiting clarity from the government on the pictorial representation of packs Feb-11 The GoI leaves excise duty unchanged in its FY12 Budget; a key positive for the company Feb-12 GoI increases basic excise duty on cigarettes by whopping 2% in its FY13 Budget Sep-12 Inaugurates its largest luxury hotel, Grand Chola, in Chennai. It has a capacity of ~6 rooms Dec-12 Begins the construction of milk processing unit in Munger, Bihar Feb-13 The GoI in its Budget again raises the basic excise duty on cigarettes by 18% May-13 For the first time during the quarter the company reports a profit in its FMCG (others) business Jul-14 GoI increases excise duty on cigarettes for a third consecutive year. It announces an increase of 11-72% in excise duty in its FY15E Budget Oct-14 Health Ministry proposes ban on loose cigarettes, higher penalty on smoking in public places Dec-14 Volume declines significantly in Q3FY15 as excessive price hike in last two years impacts growth Feb-15 Acquisition of Shower To Shower, Savlon brands from Johnson & Johnson Feb-15 Excise hike of 25% in below 65 mm category & 15% in above 65 mm category in Budget 215 Feb-16 Excise hike of 1% on cigarettes in Budget 216 Feb-17 Excise hike of 6% on cigarettes in Budget 217 Jul-17 Ad valorem VAT is replaced by the GST rate of 28% and excise duty is replaced by GST compensation cess of 5% plus specific duty as per the cigarette size. Jul-17 GST Council raised the specific cess on cigarettes in all categories below 75 mm and sharply increased the ad-valorem rate in above 75 mm category to 36% Top 1 Shareholders Rank Name Latest Filing Date % O/S Position (m) Change (m) 1 British American Tobacco PLC 3-Jun , Life Insurance Corporation of India 3-Jun , UTI Asset Management Co. Ltd. 3-Jun , Myddleton Investments Co., Ltd. 3-Jun General Insurance Corporation of India 3-Jun The New India Assurance Co. Ltd. 3-Jun Oriental Insurance Company Ltd. 3-Jun GIC Private Limited 3-Jun Rothmans International Enterprises, Ltd. 3-Jun Aberdeen Asset Management (Asia) Ltd. 3-Sep Source: Reuters, ICICIdirect.com Research Shareholding Pattern (in %) Dec-16 Mar-17 Jun-17 Sep-17 Dec-17 Promoter FII DII Others Recent Activity Buys Sells Investor name Value Shares Investor name Value Shares Nomura Asset Management Co., Ltd m 47.51m Lyxor Asset Management -58.8m -12.2m ICICI Prudential Asset Management Co. Ltd m 28.64m Goldman Sachs Asset Management International -43.5m -9.85m HDFC Asset Management Co., Ltd m 1.75m Oriental Insurance Company Ltd m -7.9m GIC Private Limited 22.29m 4.45m Capital World Investors m -7.61m Reliance Nippon Life Asset Management Limited 12.92m 3.27m Fidelity International m -7.19m Source: Reuters, ICICIdirect.com Research ICICI Securities Ltd Retail Equity Research Page 5

6 Financial summary Profit and loss statement Crore FY17 FY18E FY19E FY2E Total operating Income 4, , , ,43.6 Growth (%) Raw Material Expenses 15, , ,78.1 2,357.1 Employee Expenses 2, ,53.3 2, ,173.6 Marketing Expenses Administrative Expenses 4, , , ,66. Excise Duty Other expenses 1, , , ,882.4 Total Operating Expenditure 25, , , ,85.5 EBITDA 14, , ,98. 18,598.1 Growth (%) Depreciation 1,38. 1, ,32. 1,414.5 Interest Other Income 1, ,945. 2, ,565.7 PBT 15,53. 15, , ,72. Total Tax 5,32.1 5,12.7 5,94.2 6,546.6 PAT 1,2.9 1, , ,155.3 Growth (%) EPS ( ) Cash flow statement Crore (Year-end March) FY17E FY18E FY19E FY2E Profit After Tax 1,29. 1, , ,155.3 Add: Depreciation 1,38. 1, ,32. 1,414.5 (Inc)/dec in Current Assets , ,162.3 Inc/(dec) in CL and Provisions , CF from operating activities 1,2. 12, , ,117.5 (Inc)/dec in Investments , (Inc)/dec in LT loans & advances (Inc)/dec in Fixed Assets -2, ,12. -2,12. -2,12. Others.... CF from investing activities -2,78.3-1, , ,23.4 Issue/(Buy back) of Equity Inc/(dec) in loan funds Dividend paid & dividend tax -8, , , ,79.7 Others CF from financing activities -7, , , ,685.7 Net Cash flow ,93. -1, ,591.6 Opening Cash ,59.1 2,18.1 Cash with Bank 2, , , ,591.1 Closing Cash 2, ,65.2 4, ,17.6 Balance sheet Crore (Year-end March) FY17 FY18E FY19E FY2E Liabilities Equity Capital 1, , , ,214.7 Reserve and Surplus 44, , , ,69.1 Total Shareholders funds 45, ,36. 5, ,823.8 LT Borrowings & Provisions Deferred Tax Liability 1, , , ,871.7 Others Non-current Liabilities Total Liabilities 47, , , ,91.6 Assets Gross Block 23, , , ,433.7 Less: Acc Depreciation 9, , , ,158.8 Net Block 14, , , ,274.9 Capital WIP 3,537. 2,1. 2,1. 2,1. Net Intangible Assets Non-current Investments 8, ,37.3 9,151. 1,4.4 LT loans & advances Current Assets Inventory 7,864. 7,51.5 8,54.9 9,337.4 Debtors 2,27.5 2,36.1 2, ,41.1 Loans and Advances Other Current Assets 1, ,67.5 1,78.2 1,867.5 Cash 2, ,65.2 4, ,17.6 Current Investments Current Liabilities 6,83.1 6, , ,321.7 Creditors 2, , ,86.3 3,68. Provisions Short term debt & other CL 4,237. 4,72.2 4, ,22.3 Application of Funds 47, , , ,91.6 Key ratios (Year-end March) FY17 FY18E FY19E FY2E Per share data ( ) EPS Cash EPS BV DPS Cash Per Share Operating Ratios (%) EBITDA Margin PBT / Total Operating income PAT Margin Inventory days Debtor days Creditor days Return Ratios (%) RoE RoCE RoIC Valuation Ratios (x) P/E EV / EBITDA EV / Net Sales Market Cap / Sales Price to Book Value Solvency Ratios Debt/EBITDA.... Debt / Equity.... Current Ratio Quick Ratio ICICI Securities Ltd Retail Equity Research Page 6

7 ICICIdirect.com coverage universe (FMCG) CMP M Cap EPS ( ) P/E (x) Price/Sales (x) RoCE (%) RoE (%) Sector / Company ( ) TP( ) Rating ( Cr) FY17E FY18E FY19E FY17E FY18E FY19E FY17E FY18E FY19E FY17E FY18E FY19E FY17E FY18E FY19E Colgate (COLPAL) 1,15 1,115 Hold 28, Dabur India (DABIND) Buy 58, GSK CH (GLACON) 6,598 6,517 Buy 23, Hindustan Unilever (HINLEV) 1,35 1,36 Hold 295, ITC Limited (ITC) Buy 327, Jyothy Lab (JYOLAB) Buy 6, Marico (MARLIM) Hold 4, Nestle (NESIND) 7,672 8,58 Buy 75, Prabhat Dairy (PRADAI) Buy 1, Tata Global Bev (TATGLO) Buy 15, VST Industries (VSTIND) 3,11 3,67 Buy 5, Varun Beverage (VARBEV) Buy 9, ICICI Securities Ltd Retail Equity Research Page 7

8 RATING RATIONALE ICICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assigns ratings to its stocks according to their notional target price vs. current market price and then categorises them as Strong Buy, Buy, Hold and Sell. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock. Strong Buy: >15%/2% for large caps/midcaps, respectively, with high conviction; Buy: >1%/15% for large caps/midcaps, respectively; Hold: Up to +/-1%; Sell: -1% or more; Pankaj Pandey Head Research pankaj.pandey@icicisecurities.com ICICIdirect.com Research Desk, ICICI Securities Limited, 1st Floor, Akruti Trade Centre, Road No 7, MIDC, Andheri (East) Mumbai 4 93 research@icicidirect.com ICICI Securities Ltd Retail Equity Research Page 8

9 ANALYST CERTIFICATION We /I, Sanjay Manyal, MBA (Finance) Research Analyst, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our views about the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Terms & conditions and other disclosures: ICICI Securities Limited (ICICI Securities) is a full-service, integrated investment banking and is, inter alia, engaged in the business of stock brokering and distribution of financial products. ICICI Securities Limited is a Sebi registered Research Analyst with Sebi Registration Number INH99. 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