ITC Ltd (ITC) 285. GST woes recede; volume growth to recover. Result Update. ICICI Securities Ltd Retail Equity Research.

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1 Result Update Rating matrix Rating : Buy Target : 33 Target Period : 12 months Potential Upside : 15% What s changed? Target Changed from 32 to 33 EPS FY19E Changed from 9.9 to 1.2 EPS FY2E Changed from 1.8 to 11.2 Rating Unchanged Quarterly performance crore Q4FY18 Q4FY17 YoY (%) Q3FY18 QoQ (%) Sales EBITDA EBITDA (%) bps bps PAT Key financials Crore FY17 FY18E FY19E FY2E Revenue 39, , , ,29.3 EBITDA 14, , , ,483.6 Net Profit 1,2.9 11, , ,662. 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) 347,415.6 Total Debt (FY18) ( Crore) 11.1 Cash and Investments (FY18) ( Crore) 12,498.3 EV ( Crore) 334, week H/L 353 / 25 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 Kapil Jagasia, CFA kapil.jagasia@icicisecurities.com May 17, 218 ITC Ltd (ITC) 285 GST woes recede; volume growth to recover ITC posted decline in net revenue (net of excise duty for base quarter and in current quarter) by 4.8% YoY to 1,586.7 crore. Cigarette segment revenue numbers are not comparable. However, FMCG & hotels business saw growth of 5.8% & 5.6%, respectively. Agri business & paperboard segment saw de-growth of 5.7% and 5.2%, respectively. Cigarette volume declined ~2% after the steep price hike taken by company to pass on the GST increase in July 217 Operating profit grew by 6.9% to 4,144 crore against our estimate of 4,52 crore. Segment wise, cigarettes, hotels, paperboard, FMCG segment EBIT grew 7.6%, 12.8%,.9% and 64.2% (on a low base), respectively. Agri segment EBIT declined 8.6% On the back of higher operating profit, net profit grew 9.9% YoY to 2,932.7 crore (I-direct estimate: 3,6.2 crore) Cigarette volume set to recover on the back of low base Cigarette volumes declined ~2% during the quarter as the company has taken price hikes after a steep increase in GST in July 217. With fears on a further increase in taxation on cigarettes receding, we estimate a 3% rise in cigarette volumes (on a low base) for FY19E & FY2E along with a 6% price increase in cigarettes segment for both FY19E & FY2E. Additionally, the company continues to maintain a favourable product mix of 64 mm cigarettes (lower price point cigarette) at 35%. FMCG segment revenue grew 11.3% YoY (on a comparable corresponding numbers), largely led by volume growth & favourable product mix. Growth was strong despite a short-term impact on Aashirvaad atta sales due to circulation of malicious videos and false allegations that it contains plastic. Profitability of FMCG, hotels and paperboard business witnessed a significant improvement. EBIT for FMCG segment increased 64% to 91.2 crore in Q4FY17 on the back of a favourable product mix (foods business is a high margin one). Hotel business EBIT increased 12.9% to 75.5 crore on the back of higher room rates & increasing contribution of F&B. Continued investment & foray in new categories to drive packaged foods Though the FMCG segment reported sluggish revenue growth at 7.8% to 11,328.6 crore in FY18, we remain upbeat on the growth of the foods business as we believe 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, the company has successfully built the FMCG brands that 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) bode well for the company s long term revenue target of 1 lakh crore by FY3. Thus, we remain positive on the FMCG business and model revenue CAGR of 13.8% in FY18-2E. Attractively placed in terms of valuation; reiterate BUY Though cigarette volume growth has been subdued in the last three to four years due to high tax incidence in the GST regime, we believe cigarette volumes may surprise positively on a low base in the near term. The stock is attractively placed at the current valuation. We continue to maintain our BUY rating on the stock price with a target price of 33. ICICI Securities Ltd Retail Equity Research

2 Variance analysis Q4FY18 Q4FY18E Q4FY17 YoY (%) Q3FY18 QoQ (%) Comments Net Sales 1, , , , Net sales declined 4.8%. However, FMCG and hotels segments grew 5.8% Operating Income and 5.6%, respectively. Cigarettes volume declined ~2% Raw Material Expenses 4,1.2 4, , , Employee Expenses Other operating Expenses 1,83.3 1, , , EBITDA 4,144. 4,52.2 3, , Operating profit increased 6.9% led by cigarette price hikes after an excessive increase in GST in July 217 EBITDA Margin (%) bps bps Depreciation Interest Other Income PBT 4, , , , Tax Outgo 1,4.6 1,412. 1, , PAT 2, ,6.2 2, , On the back of higher operating profit and other income, net profit grew 9.9% YoY Key Metrics YoY growth (%) Cigarette Growth (%) N.A Cigarette numbers are not comparable FMCG (Others) Growth (%) FMCG segment reported 5.8% growth. However, on a comparable basis, the segment grew 11.3% Hotels Growth (%) Hotels business witnessed an increase in room rates and higher F&B revenues during the quarter Agri Business Growth (%) Agri growth was impacted by shortage & poor quality of AP leaf crop Paperboards Growth (%) Change in estimates FY19E FY2E ( Crore) Old New % Change Old New % Change Comments Sales , Minor change in estimates EBITDA EBITDA Margin (%) bps bps PAT EPS ( ) Assumptions Current Earlier FY17E FY18E FY19E FY2E FY19E FY2E Cigarettes ( cr) 34,2. 22, , ,11. 39, ,22.1 Cigarette Vol. Growth (%) Volume growth set to recover on low base Cigarette Price Growth (%) FMCG - Others ( cr) 1, , , , , ,94.7 Hotels ( cr) 1, , , , , ,593.6 Agri Business ( cr) 8, ,67.7 9,59.8 1, ,59.8 1,366.6 Paperboards ( cr) 5, , , , ,27.1 6,424.2 ICICI Securities Ltd Retail Equity Research Page 2

3 Segmental Analysis Exhibit 1: Cigarette volume growth set to recover Exhibit 2: Cigarette EBIT growth trend FY14 FY15 FY16 FY17 FY18 Volume growth (%) FY19 FY FY14 FY15 FY16 FY17 FY18 FY19 FY Cigarette EBIT ( crore) Cigarette EBIT Growth (%) 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 (%) FY FY15 FY FY FY18E FY19E 8.5 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 the steep GST rate increase in July 217, cigarette volumes declined ~4% in FY18. However, we expect no further increase (or minimal changes) in GST on cigarettes by FY2E. This would curb the decline in cigarettes volume in FY19E and FY2E. We factor in 3% volume growth for both FY19E and FY2E. Further, in order to pass on the existing tax burden, we estimate cigarette realisation growth of 6% each in FY19E and FY2E. Additionally, ITC s focus on growing its FMCG business (estimated to grow at a 13.8% CAGR in FY18-2E) 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 9.6% and 1.3%, respectively, in FY18-2E with EBITDA margin of 39.9% in FY2E. We value the cigarettes business at 232 (PE multiple of 25x FY2E EPS), FMCG at 6 (5x MCap/sales FY2E), paperboards at 1 (6x FY2E EV/EBITDA), agri-business at 6 (3x P/BV FY2) and hotels at 11 (2x EV/room FY2E). We also add the cash per share of 1. We believe cigarette volume growth should grow on a low base, going forward. However, revenue growth and profitability of the FMCG business would be the key driven catalyst for growth over the long term. We maintain our BUY rating on the stock with a target price of 33 per share. Exhibit 7: Sum of the parts valuation Cigarettes FMCG Paper Agri Hotels Cash per share 33 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 ( ) May-15 Jul-15 Sep-15 Dec-15 Feb-16 May-16 Jul-16 Oct-16 Dec-16 Feb-17 May-17 Jul-17 Oct-17 Dec-17 Feb May-18 (%) Price Idirect target Consensus Target Mean % Consensus with BUY Source: Bloomberg, Company, ICICI Direct Research Key events Date Dec-1 Feb-11 Feb-12 Sep-12 Dec-12 Event ITC shuts all its five cigarette manufacturing units awaiting clarity from the government on the pictorial representation of packs The GoI leaves excise duty unchanged in its FY12 Budget; a key positive for the company GoI increases basic excise duty on cigarettes by whopping 2% in its FY13 Budget Inaugurates its largest luxury hotel, Grand Chola, in Chennai. It has a capacity of ~6 rooms 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 Jul-14 Oct-14 Dec-14 Feb-15 For the first time during the quarter the company reports a profit in its FMCG (others) business 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 Health Ministry proposes ban on loose cigarettes, higher penalty on smoking in public places Volume declines significantly in Q3FY15 as excessive price hike in last two years impacts growth 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 replaced by GST rate of 28%. Excise duty replaced by GST compensation cess of 5% plus specific duty as per cigarette size Jul-17 GST Council raises specific cess on cigarettes in all categories below 75 mm and sharply increases 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 31-Mar , Life Insurance Corporation of India 31-Mar , UTI Asset Management Co. Ltd. 31-Mar , Myddleton Investments Co., Ltd. 31-Mar General Insurance Corporation of India 31-Mar The New India Assurance Co. Ltd. 31-Mar ICICI Prudential Asset Management Co. Ltd. 31-Mar GIC Private Limited 31-Mar SBI Funds Management Pvt. Ltd. 3-Apr Rothmans International Enterprises, Ltd. 31-Mar b Source: Reuters, ICICI Direct Research Shareholding Pattern (in %) Mar-17 Jun-17 Sep-17 Dec-17 Mar-18 Promoter FII DII Others Recent Activity Buys Sells Investor name Value Shares Investor name Value Shares GIC Private Limited 28.82m 7.35m Vontobel Asset Management, Inc m m HDFC Asset Management Co., Ltd. 24.3m 6.2m National Insurance Company Limited m m Matthews International Capital Management, L.L.C m 5.85m JM Financial Asset Management Pvt. Ltd m -1.36m ICICI Prudential Asset Management Co. Ltd. 2.22m 5.16m Oriental Insurance Company Ltd m -7.59m T. Rowe Price Hong Kong Limited 12.17m 3.1m Aberdeen Asset Management (Asia) Ltd m -4.7m Source: Reuters, ICICI Direct Research ICICI Securities Ltd Retail Equity Research Page 5

6 Financial summary Profit and loss statement Crore FY17 FY18E FY19E FY2E Total operating Income 4,88.7 4, , ,779.5 Growth (%) Raw Material Expenses 15, ,79. 17, ,78.4 Employee Expenses 2, , , ,2.3 Marketing Expenses Administrative Expenses 4, ,51.3 1,646.4 Excise Duty Other expenses 1, ,89.1 4, ,842.4 Total Operating Expenditure 25, , , ,296. EBITDA 14, , , ,483.6 Growth (%) Depreciation 1,38. 1, , ,546.2 Interest Other Income 1, , , ,566.3 PBT 15,53. 16, , ,457. Total Tax 5,32.1 5, ,77.7 6,795. PAT 1,2.9 11, , ,662. Growth (%) EPS ( ) Cash flow statement Crore (Year-end March) FY17E FY18E FY19E FY2E Profit After Tax 1,29. 11, , ,662. Add: Depreciation 1,38. 1, , ,546.2 (Inc)/dec in Current Assets ,8.6-2,152.8 Inc/(dec) in CL and Provisions ,26.5-1, CF from operating activities 1,2. 14, ,4.9 13,762.1 (Inc)/dec in Investments. -5,8.3 4, (Inc)/dec in LT loans & advances (Inc)/dec in Fixed Assets -2, , , ,12. Others CF from investing activities -2,78.3-9, ,19.6 Issue/(Buy back) of Equity Inc/(dec) in loan funds Dividend paid & dividend tax -8, , , ,764.5 Others CF from financing activities -7, ,95.8-1, ,738.7 Net Cash flow , , Opening Cash , Cash with Bank 2, , , ,591.1 Closing Cash 2, , ,125.2 Balance sheet Crore (Year-end March) FY17 FY18E FY19E FY2E Liabilities Equity Capital 1, ,22.4 1,22.4 1,22.4 Reserve and Surplus 44, , , ,996.2 Total Shareholders funds 45, ,4.1 51, ,216.6 LT Borrowings & Provisions Deferred Tax Liability 1, , , ,917.9 Others Non-current Liabilities Total Liabilities 47, , ,48. 55,43.3 Assets Gross Block 23, , , ,359.3 Less: Acc Depreciation 9, , , ,37.6 Net Block 14, ,861. 2, ,988.7 Capital WIP 3,537. 5,25.6 2,1. 2,1. Net Intangible Assets Non-current Investments 8, , ,73. 9,922.7 LT loans & advances Current Assets Inventory 7,864. 7, , ,261.1 Debtors 2,27.5 2,357. 2, ,381.4 Loans and Advances Other Current Assets 1, ,46.4 1, ,852.2 Cash 2, , , ,125.2 Current Investments Current Liabilities 6,83.1 8, ,547. 8,253.7 Creditors 2, , , ,42.9 Provisions Short term debt & other CL 4,237. 5, ,718. 5,159.8 Application of Funds 47, , ,48. 55,43.3 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 ICICI Direct coverage universe (FMCG) CMP M Cap EPS ( ) P/E (x) Price/Sales (x) RoCE (%) RoE (%) Sector / Company ( ) TP( ) Rating ( Cr) FY17 FY18E FY19E FY17 FY18E FY19E FY17 FY18E FY19E FY17 FY18E FY19E FY17 FY18E FY19E Colgate (COLPAL) 1,174 1,12 Hold 29, Dabur India (DABIND) Buy 65, GSK CH (GLACON) 5,948 7, Buy 24, Hindustan Unilever (HINLEV) 1,574 1,55 Hold 325, ITC Limited (ITC) Buy 347, Jyothy Lab (JYOLAB) Buy 6, Marico (MARLIM) Buy 4, Nestle (NESIND) 9,637 9,95 Buy 86, Prabhat Dairy (PRADAI) Buy 1, VST Industries (VSTIND) 3,7 3,9 Buy 4, Varun Beverage (VARBEV) Buy 13, ICICI Securities Ltd Retail Equity Research Page 7

8 RATING RATIONALE ICICI Direct endeavours to provide objective opinions and recommendations. ICICI Direct 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 ICICI Direct 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) and Kapil Jagasia, CFA, MBA (Finance), Research Analysts, 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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