ITC Ltd’s cigarettes business is on a roll, with year-on-year (y-o-y) sales growth at 16% in the first half of 2011-12. While a diversified business profile—consumer products, hotels and paper—cushions it from a downturn in any one business, the cigarettes business remains critical to sales and profit growth. This is evident in the September quarter, too.

Sales rose by 17.5% y-o-y to 5,974 crore in the September quarter; net profit increased by 21.5% to 1,514 crore. Profit growth raced ahead chiefly due to growth in other income, which rose by 45%, possibly due to rising cash and investment balances, and higher interest rates.

Cigarettes sit on display at a cigarette production plant. Photo: Bloomberg

There is a visible increase in ITC’s material costs-to-sales ratio, which was also evident in the June quarter. Material costs have risen by 24.6%, much higher than the sales growth. Costs such as employee costs and other expenditure, however, have risen at much lower rates, leading to stable margins.

The mainstay cigarettes business saw sales rise by about 16%, despite obstacles to growth such as a hike in value-added tax rates in a few states. ITC’s ability to hike cigarette prices for its key brands, along with better volume growth compared with 2010-11, would be key reasons for healthy sales growth. Segment profit margins improved by about a percentage point, which had a significant impact on overall profitability, since this business contributes 43% to sales and 77% to profit before interest and tax.

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The consumer business is showing a healthy trend of rising sales growth—27% in the September quarter—and falling losses. As ITC’s aim is to build a large consumer business, having a portfolio of profitable businesses that offset the losses incurred for building new franchises would be desirable. It seems to be coming closer to that objective.

The hotels business had a bad quarter, as the macroeconomic situation in Europe and the US appear to have affected business. Sales growth in the paper and paperboard business, too, disappointed, but margins improved. Better integration, product mix and realizations helped improve margins, said the company.

ITC’s September quarter results are reassuring, in that its key businesses are doing well. Its cigarettes business is less likely to be affected by a slowdown—perhaps not at all—than its other businesses. Since it contributes nearly four-fifths to profit, earnings growth is relatively better insulated from a slowdown. That’s a comfort for shareholders. Its results were in line with expectations, and shares rose by 1.6%.

The only medium-term worry for the company is if the government decides to hike excise duties on cigarettes in the budget after giving it a pass last year. That will have only a short-term sentiment impact, unless the hike is substantial.

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