ITC BUY RESULTS REVIEW 1QFY19 27 JUL 2018

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1 INDUSTRY FMCG CMP (as on Jul 2018) 2017) Rs Target Price Rs Nifty 10,021 11,167 Sensex 32,383 36,985 KEY STOCK DATA Bloomberg ITC IN No. of Shares (mn) 12,161 12,218 MCap (Rs bn)/(us$ mn) 3,509/54,743 3,509/51,102 6m avg traded value (Rs mn) 4,144 3,153 STOCK PERFORMANCE 52 Week high / low Rs / M 6M 12M Absolute (2.2) 16.6 Relative (6.9) (3.3) (4.0) (0.5) (16.4) 1.1 SHAREHOLDING PATTERN Promoters FIs & Local MFs FPIs Public & Others Source : BSE Naveen Trivedi naveen.trivedi@hdfcsec.com Siddhant Naveen Trivedi Chhabria siddhant.chhabria@hdfcsec.com naveen.trivedi@hdfcsec.com Re-rating on the cards ITC s net revenues grew by 13.5% (exp of 8.2%) beating estimates for all segments except Paper business. Cigarette value growth was at ~9% (exp. 8%) with volume growth of ~1% (exp. flat). EBITDA/ APAT grew by 7/10% vs. exp. of 12/10%. ITC has consistently improved cigarette performance after seeing steep rise in taxes in FY18. As per the management, cigarette volume trajectory is gradually improving. Therefore, we believe ITC can deliver low-mid single digit volume growth in the coming 3-4 quarters supported by favourable base (-6/-4-3% in 2Q/3Q/4QFY19) and expectation of no steep rise in taxes (healthy GST collections). FMCG revenues grew by an impressive 14% (like-to-like) on a relatively firm base (9% in 1QFY18), driven by branded packaged foods and personal care products. Hotels (up 12% YoY) continued to enjoy improved ARR and occupancy rates along with favourable F&B base (highway ban). Agri business rebounded with 14% growth, while Paper performance remained weak. ITC s cigarette biz has registered ~10/9% revenue CAGR in the last 10/5 years, despite punitive taxes. Our 9% revenue CAGR estimate over FY18-21E looks achievable owing to improving consumption dynamics and favorable RESULTS REVIEW 1QFY19 27 JUL 2018 ITC BUY value accretive, with improving franchise. We expect ~14% revenue CAGR here over FY18-21E. ITC is the market leader in cigarettes (>80% by value), notebooks, valued-added paperboards and a significant player in biscuits. Our long term positive stance on ITC derives from its status of being the cheapest consumer large-cap stock in India. At 26x FY20E EPS, ITC trades at an unfair discount of ~35% to the sector. Reiterate BUY. Our TP is Rs 367, at 32x Jun-20E EPS. Highlights for the quarter Sequential recovery in cig. volume: The worst is now behind for cigarettes after being impacting by GST rate hike (July-17). We expect ~4% vol. growth in FY19. FMCG EBITDA up 86%: FMCG EBIT margins expanded by 154bps to 1.7% driven by richer mix and oplev. EBITDA was up by 86% to Rs 1,280mn vs. Rs 680mn YoY despite product launches. APAT grew by 10%: EBITDA grew by healthy 7% to Rs 42.02bn (in-line). Lower other income (-15%), lower interest (-29%) and lower taxes (-64bps) led to 10% APAT growth to Rs 28.18bn (exp. Rs 28.48bn). Near-term outlook: With healthy GST collections, we don t anticipate a steep rise in taxes in the near-term. Cig. volumes will continue to gain momentum, driving earnings growth. We see risk reward favoring ITC. base of FY18. Non-cigarette businesses (esp. FMCG), are Financial Summary (Rs mn) 1QFY19 1QFY18 YoY 4QFY18 QoQ FY17 FY18 FY19E FY20E FY21E Net Revenue 108,746 99, , , , , , ,187 EBITDA 42,021 37, , , , , , ,675 APAT 28,187 25, ,327 (3.9) 104, , , , ,823 EPS (Rs) (3.9) P/E (x) EV/EBITDA (x) Core RoCE HDFC securities Institutional Research is also available on Bloomberg HSLB <GO>& Thomson Reuters

2 Net revenues grew by 9.2% (exp of 8.2%) Cigarette volumes grew by 1% (exp flat) FMCG business grew by 14% (like-like) driven by packaged foods and personal care products Despite several headwinds, ITC registered healthy 10% APAT growth Exceptional item in FY18 is on account of tax provision written-back (Tamil Nadu entry tax) In spite of two tax hikes (FY18 Budget and GST), the company registered 9% earnings growth during FY18 Quarterly Financials (Standalone) Year to March (Rs mn) 1QFY19 1QFY18 YoY 4QFY18 QoQ FY18 FY17 YoY Gross Revenue 181, , , , , Net Revenue* 108,746 99, , , , Material Expenses 41,094 38, , , ,763 (1.2) Employee Expenses 7,430 6, , ,875 24, Other Operating Expenses 18,201 16, ,568 (11.5) 68,091 70,900 (4.0) EBITDA 42,021 37, , , , Depreciation 2,987 2, ,040 (1.7) 11,454 10, EBIT 39,034 34, , , , Other Income 4,039 4,768 (15.3) 5,165 (21.8) 21,298 19, Interest Cost (29.3) 232 (68.4) PBT before exceptional 42,999 39, ,333 (0.8) 164, , Exceptional - - na - na 4,129 - na PBT 42,999 39, ,333 (0.8) 168, , Tax 14,813 13, , ,285 53, RPAT 28,187 25, ,327 (3.9) 112, ,009 1 APAT 28,187 25, ,327 (3.9) 110, , EPS (3.9) % Of Net Revenue 1QFY19 1QFY18 YoY (bps) 4QFY18 QoQ (bps) FY18 FY17 YoY (bps) Material Cost (75) (99) Employee Expenses Other Expenses (32) 19.0 (228) (93) EBITDA Tax Rate (64) (80) APAT (120) Note: Excise duty reversal we have included in the other expenses Page 2

3 Cigarette business grew by ~9% during the quarter with ~1% volume growth. We were expecting 8% cigarette growth with flat volumes FMCG biz on like-to-like basis grew by 14% (17% adjusting for input tax credit), led by healthy growth in branded packaged foods and personal care Hotel biz grew by 12% driven by improvement in ARR and growth in F&B sales Agri business rebounded with 14% growth after a painful FY18 Paper business was weak (flat growth). With recovery in FMCG volumes we expect paper business to rebound in the near-term Quarterly Segmental (Reported) Year to March (Rs mn) 1QFY19 1QFY18 YoY 4QFY18 QoQ FY18 FY17 YoY Segmental Revenues Cigarettes* 51,276 87,742 (41.6) 49, , ,020 (32.7) FMCG 28,700 26, ,518 (6.0) 113, , Hotels 3,413 3, ,080 (16.4) 14,175 13, Agribusiness 31,513 27, , ,677 82,646 (2.4) Paperboards, Paper & Packaging 13,558 13,598 (0.3) 13, ,496 53,629 (2.1) Total 128, ,003 (18.7) 115, , ,830 (17.7) Less: Inter-segment revenue 21,238 20, , ,005 44, Total 107, ,222 (21.9) 107, , ,017 (20.1) Segmental EBIT Cigarettes* 35,584 32, , , , FMCG (45.0) 1, Hotels (82.5) 1,398 1, Agribusiness 1,945 2,351 (17.3) 1, ,486 9,058 (6.3) Paperboards, Paper & Packaging 2,957 2, , ,422 9, Total 41,119 37, , , , Less: (a) Interest Cost & Bank Charges (29.3) 232 (68.4) (b) Other Un-allocable Expenses (1,954) (1,777) 1 (3,177) (38.5) (14,028) PBT 42,999 39, ,333 (0.8) 168, , Capital Employed Cigarettes 32,113 44,294 (27.5) 33,321 (3.6) 32,113 44,294 (27.5) FMCG 67,115 65, , ,115 65, Hotels 50,921 48, , ,921 48, Agribusiness 25,610 27,248 (6.0) 25, ,610 27,248 (6.0) Paperboards, Paper & Packaging 60,970 57, , ,970 57, Total 236, ,473 (2.4) 225, , ,473 (2.4) Unallocated corporate assets 307, , , , , Total capital employed 544, , , , , *Cigarette revenue growth is not comparable Page 3

4 EBIT margin expansion for FMCG business was driven by enhanced scale, product mix enrichment and cost management initiatives notwithstanding higher investments in brand building and gestation costs of new categories EBIT Margin (Reported) Year to March (Rs mn) 1QFY19 1QFY18 YoY (bps) 4QFY18 QoQ (bps) FY18 FY17 YoY (bps) Cigarettes* , (162) ,147 FMCG (124) Hotels (1,462) Agribusiness (234) 6.9 (68) (44) Paperboards, Paper & Packaging Total (309) *Cigarette EBIT margin is not comparable Hotels EBIT expansion was driven by higher room rates and operating leverage Paper EBIT expansion was driven by richer mix, higher utilisation and benign input prices Page 4

5 Sequentially volumes have improved. We expect positive volume growth in FY19 Cigarette Value Growth Mar-14 9 Cigarette Volume Growth (2) (3) (4) (13) (15) (15) (17) (4) (1) (1) 1 (4) (3) (6) Mar-14 1 Cigarette EBIT growth of ~9% is healthy since the business has been impacted by punitive taxes Cigarette Price Growth Cigarette EBIT Growth Mar-14 Mar-14 Page 5

6 FMCG business growth of 10% is largely driven by volume Hotel business is on a strong momentum driven by higher occupancy rates and ARR Paper business is expected to recover in the short to medium term Encouraging to see rebound in agro business FMCG Revenue Growth Agri Revenue Growth (11) (29)(29) (29) (10) (7) (1) (8) (6) Mar Hotel Revenue Growth Paper Revenue Growth Mar-14 (5) (5) 4 (2) (2) 5 3 (2) 0 (0) (2) 10 6 (4) (5) Mar (0) Page 6

7 Assumptions FY17 FY18 FY19E FY20E FY21E Cig. Revenue Gr Cig. Volume Gr 0.6 (3.0) FMCG Revenue Gr Hotels Revenue Gr Agri. Revenue Gr 12.6 (2.3) Paper Revenue Gr 12.1 (2.2) Gross Margin Employee (% of sales) ASP (% of sales) Rent (% of sales) Distribution (% of sales) Cont. Manf. (% of sales) EBITDA Margin Tax Rate Estimate change FY19E FY20E FY21E New Old Change Change Change New Old New Old Revenue 472, ,097 (0.3) 519, ,611 (0.3) 570, ,940 EBITDA 180, ,593 (0.9) 200, ,095 (1.0) 220, ,241 (0.3) APAT 122, ,347 (0.5) 135, ,113 (0.5) 149, , EPS (0.9) (0.9) (0.3) Page 7

8 Peer Set Comparison Company MCap (Rs bn) CMP (Rs) Reco. TP (Rs) EPS (Rs) P/E (x) EV/EBITDA (x) Core RoCE FY19E FY20E FY21E FY19E FY20E FY21E FY19E FY20E FY21E FY19E FY20E FY21E HUL 3,605 1,669 NEU 1, ITC 3, BUY GCPL 850 1,248 NR 1, Britannia 774 6,450 NEU 6, Dabur BUY Marico BUY Colgate 295 1,084 NEU 1, Emami BUY Jub. Food 184 1,396 BUY 1, Source: HDFC sec Inst Research Page 8

9 High rates of tax on cigarettes provide attractive tax arbitrage opportunities to unscrupulous players, fanning the growth of illegal cigarette trade in the country The legitimate cigarette industry has declined steadily since at a compound annual rate of 4.8% p.a., illegal cigarette volumes in contrast have grown at about 5% p.a. India s Tobacco Consumption Tobacco consumption share Other tobacco products, 89% Legal cigarettes, 11% Tax revenue share Other tobacco products, 13% Legal cigarettes, 87% Per capita consumption of Tobacco in India Per annum (No) 3,000 2,500 2,000 1,500 1, ,786 Russian Federation 1,841 1,711 Japan China 1,028 USA Pakistan Nepal Bangladesh India Affordability (% of per capita GDP required to purchase 100 packs of 20 cigarettes of most sold brand USA Russia Germany Canada China Australia UK Malaysia Pakistan India Page 9

10 Income Statement (Rs mn) FY17 FY18 FY19E FY20E FY21E Net Revenues 428, , , , ,187 Growth Material Expenses 160, , , , ,345 Employee Expense 36,317 37,609 39,882 44,074 48,770 ASP Expense 8,107 8,255 10,401 11,959 13,114 Distribution Expense 8,560 7,821 8,510 9,360 10,263 Other Expenses 60,201 57,420 63,806 70,568 78,020 EBITDA 154, , , , ,675 EBITDA Growth EBITDA Margin Depreciation 11,528 12,363 12,997 14,227 15,351 EBIT 142, , , , ,324 Other Income (Including EO) 17,615 18,319 19,702 20,089 22,415 Interest PBT 160, , , , ,829 Total Tax 55,491 59,164 63,208 69,729 77,122 RPAT 104, , , , ,823 Exceptional Gain/(loss) - 2, Adjusted PAT 104, , , , ,823 APAT Growth Adjusted EPS (Rs) EPS Growth Balance Sheet (Rs mn) FY17 FY18 FY19E FY20E FY21E SOURCES OF FUNDS Share Capital - Equity 12,147 12,204 12,204 12,204 12,204 Reserves 451, , , , ,204 Total Shareholders' Funds 464, , , , ,409 Minority Interest 2,947 3,345 3,258 3,157 3,042 Long Term Debt Short Term Debt Total Debt Net Deferred Taxes 18,333 18,749 19,000 19,271 19,564 Other non current liabilities 2,174 2,596 2,596 2,596 2,596 TOTAL SOURCES OF FUNDS 487, , , , ,957 APPLICATION OF FUNDS Net Block 157, , , , ,631 CWIP 49,180 77,353 78,353 67,153 58,194 Goodwill 2,314 2,314 2,314 2,314 2,314 LT Loans & Advances 20,849 21,014 23,534 26,356 29,518 Total Non-current Assets 230, , , , ,657 Inventories 81,161 74,951 78,776 85,467 92,876 Debtors 24,743 26,823 29,186 32,100 35,200 Other Expenses 17,471 26,523 27,853 29,632 31,948 Cash & Equivalents 205, , , , ,416 Total Current Assets 328, , , , ,440 Creditors 26,593 34,962 38,458 42,304 46,534 Other Current Liabilities & Provns 44,430 57,367 63,169 69,562 76,606 Total Current Liabilities 71,023 92, , , ,140 Net Current Assets 257, , , , ,300 TOTAL APPLICATION OF FUNDS 487, , , , ,957 Page 10

11 Cash Flow Statement (Rs mn) FY17 FY18 FY19E FY20E FY21E Reported PBT 160, , , , ,829 Non-operating & EO Items (2,257) (3,379) Interest Expenses (8,789) (8,748) (9,046) (9,785) (10,582) Depreciation 11,528 12,363 12,997 14,227 15,351 Working Capital Change ,364 (739) (3,968) (4,712) Tax Paid (54,916) (59,996) (62,957) (69,458) (76,829) OPERATING CASH FLOW ( a ) 106, , , , ,058 Capex (30,715) (27,985) (36,299) (15,801) (25,041) Free Cash Flow (FCF) 75, ,709 89, , ,017 Investments (10,749) (50,814) (15,000) (15,000) (15,000) Non-operating Income 8,955 7,660 9,852 10,640 11,491 INVESTING CASH FLOW ( b ) (32,509) (71,139) (41,448) (20,161) (28,550) Debt Issuance/(Repaid) (132) Interest Expenses (255) (486) (805) (855) (909) FCFE 75, ,247 89, , ,129 Share Capital Issuance 10,670 9,128 (0) (0) - Dividend (83,330) (70,884) (75,647) (82,783) (91,327) Others FINANCING CASH FLOW ( c ) (73,010) (62,211) (76,435) (83,618) (92,214) NET CASH FLOW (a+b+c) 754 (1,656) 8,277 32,321 29,294 EO Items, Others 33,403 (978) Closing Cash & Equivalents 29,674 28,996 37,273 69,594 98,888 Key Ratios FY17 FY18 FY19E FY20E FY21E PROFITABILITY GPM EBITDA Margin EBIT Margin APAT Margin RoE RoIC (or Core RoCE) RoCE EFFICIENCY Tax Rate Fixed Asset Turnover (x) Inventory (days) Debtors (days) Other Current Assets (days) Payables (days) Other Current Liab & Provns (days) Cash Conversion Cycle (days) Net D/E (x) (0.4) (0.5) (0.5) (0.5) (0.5) Interest Coverage (x) PER SHARE DATA (Rs) EPS CEPS Dividend Book Value VALUATION P/E (x) P/BV (x) EV/EBITDA (x) EV/Revenues (x) OCF/EV FCF/EV FCFE/Mkt Cap Dividend Yield Page 11

12 RECOMMENDATION HISTORY ITC TP Date CMP Reco Target 28-Jul BUY Oct BUY Oct BUY Nov BUY BUY Jan BUY Jan BUY Jan BUY Feb BUY Apr BUY May BUY Jul BUY Jul BUY Jul-17 Aug-17 Oct-17 Nov-17 Jan-18 Feb-18 Apr-18 May-18 Jul-18 Rating Definitions BUY : Where the stock is expected to deliver more than 10% returns over the next 12 month period NEUTRAL : Where the stock is expected to deliver (-)10% to 10% returns over the next 12 month period SELL : Where the stock is expected to deliver less than (-)10% returns over the next 12 month period Page 12

13 Disclosure: We, Naveen Trivedi, MBA & Siddhant Chhabria, PGDBM, 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. HSL has no material adverse disciplinary history as on the date of publication of this report. 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. Research Analyst or his/her relative or HDFC Securities Ltd. does not have any financial interest in the subject company. Also Research Analyst or his relative or HDFC Securities Ltd. or its Associate may have beneficial ownership of 1% or more in the subject company at the end of the month immediately preceding the date of publication of the Research Report. 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