ITC’s core cigarettes segment has shown strong resilience to the impact of VAT managing to restrict the drop in cigarette volumes to ~2% in FY08. It has stopped production of non-filter cigarettes post the hike in excise duties on the same.
This segment was contributing only ~10% of revenues and ~8% of profits. ITC accounts for almost 3/4th of the filter cigarettes market and will be the major beneficiary of the shift in demand from non-filter to filter cigarettes.
We believe ITC will continue to dominate the cigarette industry with its strong volume and value market share of 73% and 84% respectively.
The company has started investing cash flows from its cigarette business into long-gestation businesses such as hotels and paper. It is slowly and gradually lowering its dependence on the high-margin cigarettes business and increasing its focus on non-cigarette businesses.
ITC has entered into the personal care category under the brands Essenza Di Wills, Fiami Di Wills, Vivel Di Wills and Superia. With its extensive food product portfolio, ITC aims to become the largest food company in India within the next five years.
Outlook and valuation
In the coming quarters, we believe the higher cigarette prices would get successfully absorbed by the industry and ITC’s cigarette volume decline would significantly reduce.
Outlook for the non-cigarette businesses such as hotels and paper remains positive with continued demand buoyancy while the FMCG — others segment is expected to turn profitable by FY10.
With the entry into the personal care category, we expect ITC to become a tough competitor for Hindustan Unilever and Godrej Consumer Products.
Also, strong cash flows from cigarette business can be invested in advertising heavily to build the personal care portfolio in the initial stage. We recommend a BUY with a target of Rs214.