Why did ITC witness slide in stock price despite in-line results?

The street was disappointed with the cigarette division’s performance; however, EBIT growth could accelerate to double-digits in next 1-2 quarters.

Jan 24, 2019 03:01 IST India Infoline News Service

ITC stock price closed 6% down from the day’s high in yesterday’s trading session despite the fact that the quarterly results were broadly in-line with the consensus estimates. The reason for the fall, in our view, was lower EBIT growth for the cigarette division at 8.8% instead of double digit growth (11-12%) expectation as per consensus estimates.  This quarter was expected to be a break in the trend of the past 10 quarter’s single digit EBIT growth of the cigarette division. We believe that the street was disappointed with the cigarette division’s performance (slow pace of price increases and consequent impact on EBIT growth), and hence, stock price took the beating.

However, we believe that a rational tax regime, stable growth in gross sales at 8-9%, and revival in volume growth and good performance in non-cigarette segments is good news and we re-iterate our positive stance on the stock. (Read more)

Reasons impacting the EBIT growth of cigarette division:
  • High cost tobacco being consumed this quarter.
  • Capsule filters increasing salience from ~2% to ~7% yoy. These filters are imported and expensive; however, company plans to localize manufacturing in the next few months to curb cost.
  • Higher growth in DSFT (64mm) vs. the overall cigarette division; (DSFT has lower EBIT per stick vs. the overall portfolio).
 
However, we believe that EBIT growth of cigarette segment can accelerate in the next 1-2 quarters to the double-digit mark aided by:
  • Company has taken selective price increases. In addition to the increase in Flake Filter (Rs7 to Rs8) ~3 months back, recently certain DSFT brands’ prices have increased from Rs5 to Rs5.5 and Navy cut (RSFT) has also been increased. There could be some other selective price increases too.
  • Localization of capsule filters could reduce costs in 1QFY20.
 
This quarter’s cigarette revenue growth of 9.6% was aided by 7.5% volume growth and 1.1% realisation growth. We believe that next quarter net sales growth could marginally accelerate as we may see the increased contribution of realisation in revenue.
 
What happened to the other segments?
 
While EBIT growth in cigarettes was 2-3% below estimate, overall EBIT did not disappoint as FMCG (others) reported a strong EBIT growth of 63.1% yoy followed by paperboard and hotels at 23.8% and 10.1%, respectively. FMCG – others was aided by enhanced scale, product mix enrichment and cost management initiatives, while Hotel segment was driven by improvement in average room rent (ARR). Profitability of the agri segment (EBIT down by 14.8% yoy) was impacted by subdued demand for leaf tobacco (which is a relatively higher margin business) in international markets, relatively steeper depreciation in currencies of competing origins in recent years and high cost leaf tobacco inventory.

Segmental growth (%) on yoy basis:
 
Sales EBIT EBIT margin* Comments
Cigarettes 9.6 8.8 -43 ~8% volume growth; muted price hike led to disappointment
FMCG - Others 11.5 63.1 76 Enhanced scale, product mix enrichment and cost management initiatives aided performance
Hotels 11.7 10.1 -20 Driven by improvement in ARR
Agri 25.7 -14.8 -491 Revenue grew strongly led primarily by wheat and oilseeds; subdued demand and high cost inventory of leaf tobacco impacted profitability
Paperboard 20.5 23.8 57 Driven by strong demand and capacity augmentation in value added paperboard and décor segments
 Source: Company, IIFL Research; *EBIT margin change is in bps
 
We believe that the company is looking at delivering healthy overall EBIT growth and since other businesses are doing well, the cigarettes division is getting some space to stabilize and grow volumes as the company has witnessed 15% volume decline in this division over FY14-18. We are estimating cigarette volume growth of 6% for FY19E and 1% each for FY20E and FY21E with an ~8% price hike in each FY20E and FY21E.
 
We continue to recommend Buy on the stock with a target price of Rs335. At CMP, stock is trading at 22x FY21E EPS. 

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