ITC ripe for a rerating

Volume recovery in cigarettes and scaling up of the FMCG business in FY19 are the positives

Traction for its fastmoving consumer goods (FMCG) portfolio led by launches, receding threat of higher taxation on cigarettes as well as attractive valuations are expected to lead to a rerating of the ITC stock. Analysts expect both the non-tobacco business as well as cigarettes to clock good volume growth as well as improved profitability in FY19.

Among the key triggers is the new product diversification and growth of its existing FMCG portfolio, which has in a short span of time resulted in three large brands comprising Aashirvaad, recently crossed the ~40-billion mark, Sunfeast (a ~30-billion brand) and Bingo, Yipee, Classmate with sales of more than ~10 billion each. Though FMCG also includes personal care, lifestyle retailing, safety matches and incense sticks, the company’s significant success in the packaged foods segment is keeping investors excited. ITC is among the top two in branded wheat flour, cream biscuits, snack food and noodles categories. Among other sub-segments within the packaged food, it is present in the premium chocolates under the Fabelle brand, coffee under Sunbean in addition to its juice brand B Natural.

ITC is looking to replicate its success in the branded wheat segment, where it leads with a 28 per cent market share, by launching products/foraying into new segments under the umbrella of the flagship Aashirvaad brand. One such would be the liquid milk segment, where it already markets valued-added products such as Aashirvaad Svasti ghee and has recently launched milk pouch in Bihar. ITC will gradually scale up its presence in the milk pouch space, estimated at ~720 billion.

The other is the branded rice segment. While it is currently exporting rice, the launch at the end of the current year will mark its foray into the domestic market in the ~220-billion branded rice market.

Given the existing base and the launch of products, the company is hoping to more than double its revenue from the Aashirvaad brand to ~100 billion over the next five years.

In the biscuit business, the company is expected to do well given its focus in the mid to premium segments, which is growing faster compared to the value segment, resulting in higher market share. What should buoy growth is an expansion of its distribution network comprising 2.7 million outlets. After the implementation of the goods and services tax (GST), ITC would be a major beneficiary of a shift in consumption pattern from the unorganised to organised segment and the supply chain. Moreover, demand, especially that in rural areas, is recovering.

While the FMCG business contributed 19 per cent to revenues in FY17, given the growth from existing and new segments, brokerages estimate it to account for about 28 per cent by 2020. Similarly, the business, which achieved break- even at the operating level in FY13 after suffering losses for 11 years, is expected to improve margins from the current low single-digits to mid-single digits over the next two to three years.

Analysts at ICICI Securities say revenue growth and profitability of the FMCG business would be the key catalyst for ITC’s long term growth. It would also help the company achieve sales of ~1 trillion from the FMCG segment by 2030 from ~114 billion estimated for FY18.

Meanwhile, what should add to the operating profit is the paper and packaging business, which is the second-largest contributor to operating profit after cigarettes at 7 per cent though in revenue terms it accounts for 11 per cent of sales. The paper and packaging segment is witnessing margin expansion on the back of higher volumes and lower raw material prices. Margins of the division, which were at 18 per cent in FY17 are expected to improve by over 250 basis points over the next two years.

Further, non-tobacco operations, according to analysts at JP Morgan, should do better in FY19 led by the good performance of the FMCG business and a demand revival in the hotel and paper division. This would help grow the non-tobacco business’ operating profits by 14 per cent annually over FY18-20.

The near-term trigger for India’s largest cigarettes maker is relief on the tax front as the GST council at the recent meeting left rates untouched. After a muted 1.5 per cent growth in FY17 and a sharp fall in volumes in the previous quarters of FY18, cigarette volumes have started recovering from December 2017. Volumes in FY19 are expected to grow at 5.6 per cent against an expected drop of 3.4 per cent in FY18. Better growth prospects for this business is critical as cigarettes still contribute about 86 per cent of ITC’s operating profit.

Given the recovery in cigarette volumes and profit in FY19, analysts at Antique Stock Broking said the stock, which is trading at a 10-year high valuation discount of 32 per cent to FMCG peers, was deeply undervalued.