Dependence on cigarette biz to persist
Its share of Ebit could be as higher as 82% in FY23 ESG issues are a overhang earnings outlook muted ‘Neutral’ maintained
Cigarettes’ EBIT dependence will stay unaltered by ongoing ‘Other FMCG’ development. We retain our Neutral rating on the ITC stock due to the following components: While ITC efforts on the general ESG (environmental, social, and corporate governance) front are definitely commendable, the concern more than its Cigarettes business enterprise from an ESG viewpoint remains at play – as more funds turn ESG-compliant (each globally and in India), affecting the valuations of international cigarette businesses, which includes ITC.
Even if ongoing development and profitability improvement in ‘Other FMCG’ leads to a 50% Ebit development CAGR more than FY20–23e, the Cigarettes business’ contribution to general Ebit just barely reduces from 85% in FY20 to 82% in FY23e. Hence, this does not actually move the needle from a Cigarettes dependency viewpoint. Part of the margin development in ‘Other FMCG’ in H1FY21 could also be ephemeral, driven by a mixture of elevated in-property consumption and soft commodity expenses.
In our view, the possibility of GST hikes in the Feb’21 spending budget or any of the GST council meets remains higher provided weak government finances. Importantly, even in the 31-month period among Jul’17 (GST enhance) and Feb’20 (NCCD enhance) – when there was no GST enhance on Cigarettes – cigarette volumes and Ebit overall performance had been tepid.
The earnings development outlook in the latter half of the final decade significantly weakened v/s the former half, and ROEs saw sharp decline (regardless of corporate tax cuts). The FY20–FY23e outlook does not seem most likely to alter on either of these fronts. PBT development in the final 5 years has been ~6.6% and is most likely to be about 7.3% in the subsequent 3 years. With acquisition-led development gaining traction and self-imposed close to-term moratorium on capex sooner or later becoming lifted, ROE could come below additional stress more than the medium term.
Valuation and view
Despite the corporate tax cuts (of which ITC was a considerable beneficiary), return ratios have come off by ~1000bp from the mid-30 levels noticed in the course of 2011–15. If a sustained higher dividend payout beyond the stated 80-85% levels, combined with reduced capex (provided the weak demand atmosphere), eventuates, it would give some respite amidst a challenging outlook for ITC’s income development and earnings development prospects. But a sturdy dividend yield alone is not sufficient of a comfort, specifically as it is in line with international peers in the Cigarettes business enterprise.
Valuations would trade closer to international tobacco peers provided (i) the dependence on the Cigarettes business enterprise remaining higher (ii) far weaker earnings development and ROCE v/s the earlier component of final decade and (iii) the persistent threat of additional ESG-primarily based promoting by investors. BAT trades at 8.1x CY21 EPS and Philip Morris at 13.9x CY21 EPS. Taking the typical multiples of these two international peers and providing ITC a ~30% premium, as effectively as rolling forward to December 2022 EPS, we get TP of Rs 200 (14x December 22 EPS).