ITC has managed to register stable earnings growth with a marginal decline in volumes despite heavy tax burden and regulatory restrictions on cigarettes.
With its strong brand recognition and product portfolio, ITC has always been well placed to pass on any tax burden to consumers. The pictorial warnings and smoking ban are not likely to have a major impact on the segment due to implementation issues.
The Government has levied additional excise duty on the non-filter cigarettes mainly to bring them on par with filter cigarettes. ITC exited from it post excise hike as it had a very small presence.
The demand uptrade from non-filter to filter and premium filter cigarettes (post excise duty hike) is expected to be almost over 75%. ITC being the market leader in the filter cigarettes category will be the major beneficiary from this shift in demand.
We expect cigarette revenues to increase by ~9% yoy during FY09 despite a decline of ~3% in volumes as a result of the full impact of price hikes and improved realizations on account of favourable product mix.
ITC over the years has been investing cash flows from its cigarette business into various lucrative segments like foods, personal care, hotels and paper.
With the paperboard division coming out of a major capex cycle and a reduction in losses from FMCG-others division from FY10E, we expect the non-cigarette businesses to become self-sufficient.
The agri division continues to provide a strong support as an excellent raw material sourcing base. Hotels segment though is likely to register slower growth in FY10E due to economic slowdown and terror attacks.
ITC remains one of our top pick in the sector given the strong resilience in its core cigarette business.
We expect the company to register 17% CAGR in net profit over FY09-11. At the current market price of Rs175, the stock is trading at 14.4x FY11E EPS of Rs12.1.
We recommend BUY with a price target of Rs216, an upside of 23.2%.