The Q3FY2009 results of ITC are in line with our estimates. The net sales growth of 10% is below our expectation whereas the operating profit margin (OPM) of 35.7% is above our expectation.
The cigarette segment delivered an impressive performance with its gross sales growing by 10.5% y-o-y (net sales up 17.7% y-o-y) to Rs3,901.5 crore and profit before interest and tax (PBIT) growing by 18% to Rs1,134.1 crore.
On the back of an improved revenue mix and price increases, the segment’s PBIT margin rose by 184 basis points y-o-y to 29.1%.
However, apart from cigarettes the performance of all the other segments, i.e. non-cigarette fast moving consumer goods (FMCG), hotels, agri-products and paperboards, paper and packaging, was disappointing.
The growth rate of the non-cigarette FMCG sales dipped sharply from approximately 49% y-o-y in FY2008 to 29% y-o-y in H1FY2009 and further to just 11.7% y-o-y for Q3FY2009 to Rs722.3 crore.
This, we believe, is a cause for worry as the segment is seen as the key growth driver for ITC.
Also, the business continues to suffer heavy losses and any improvement in profitability is possible only through an increase in the scale of operations.
For the quarter the segment posted a PBIT loss of Rs127 crore against that of Rs64.5 crore in Q3FY2008.
The hotel segment’s revenues declined by 13.7% y-o-y to Rs270.5 crore due to a decline in the occupancies and pressure on the average room rate on account of the economic slowdown and the impact of the Mumbai terror attacks on tourist arrivals.
The PBIT margin of the segment declined from 43.9% in Q3FY2008 to 33.7% in Q3FY2009, leading to a sharp decline of 33.9% in the PBIT to Rs91.1 crore.
The sales of the agribusiness declined by 6.2% y-o-y to Rs621.5 crore and are lower than expected. However, the PBIT of the segment increased by 80.8% y-o-y to Rs50.2 crore as the margin in the business almost doubled to 8.1%.
The sales of the paperboards, paper and packaging segment increased 10.9% y-o-y (lower than expected). However, the growth rate is much lower than 20%+ witnessed in H1FY2009.
Also, the PBIT margin dipped 300 basis points y-o-y to 16.6%. Hence, the PBIT declined by 6.1% to Rs111.1 crore.
Overall, the company posted a better than expected OPM of 35.7% (against 35.8% in Q3FY2008) despite a 187-basis-point increase in the raw material cost as a percentage of sales primarily due to a 182-basis-point decline in the other expenses as a percentage of sales.
Thus, the operating profit grew by 9.6% y-o-y and the net profit grew by 8.7% y-o-y to Rs903.2 crore.
Outlook and valuation
Though the Q3FY2009 results (in terms of absolute profits) are in line with our expectations, a deeper scrutiny of the numbers raises concerns regarding the outlook for the company’s non-cigarette FMCG business.
We have reduced our FY2009 and FY2010 estimates by 2.7% and 5.3% respectively. At the current market price of Rs171 the stock trades at 19.3x its FY2009E earnings of Rs8.8 and 16.6x its FY2010E earnings of Rs10.3.
As a result of revision in the earnings estimates we are revising our price target to Rs206 (at 20x FY10E earnings).