When expectations are rock bottom, exceeding them is not difficult. That is one way of looking at ITC Ltd’s shares rising 5.2% on Friday after its net profit grew 10.2% in the June quarter. While earnings’ growth was better than expected, volume growth in its cigarettes business caught attention, with analysts estimating it at 1-1.5% over a year earlier compared to their expectations of no change.

ITC’s underperforming cigarettes business was the main reason its shares were not doing well. A steep increase in the cess on cigarettes under the goods and services tax regime had resulted in a decline in volume growth in the previous three quarters. An unfavourable regulatory regime made matters worse. Is this all in the past now?

One factor that may be working in ITC’s favour is a steady improvement in consumption demand in the economy. That could be driving some growth to ITC’s cigarettes portfolio. Also, the tax efficiencies under the GST regime may be helping ITC, just as it does other consumer companies.

The remaining three quarters of FY19 should also see cigarette volume growth, partly with a low base effect helping. Volume declined in the year-earlier period, after ITC raised prices sharply to compensate for higher taxes.

While a really bad FY18 may be followed by a somewhat better FY19, ITC still faces threats from punitive taxation and public health policy. However, if duties on cigarettes are left unchanged in the next budget, it can signal a more stable taxation regime ahead for cigarettes. Given the uncertainty, wait and watch is the best policy.

While these risks have to be managed, ITC’s cash generating machine seems unaffected by all these events.

In FY18, its annual report shows that its net cash from operations rose 24% to 13,169 crore, even as its operating profit rose by 8.5%. Growth and level of cash generated gives it enough flexibility to pay dividends and still have enough money left over for investing in other businesses. That also shows that even in a tough year, the cigarettes business has a lot of fight in it.

Its FMCG business may require some of that cash, as ITC continues to invest in new categories and products. The quarter did see 14% sales growth on a comparable basis, and it also reported a slender profit. Still, the number of relatively new categories it has entered is likely to continue putting pressure on margins.

That means cigarettes will continue to be the mainstay for earnings growth, while the FMCG business may provide impetus to sales. Even in the June quarter, 85% of the increase in segment profit was contributed by the cigarettes business alone.

Analysts are, on an average, expecting earnings growth to be about 12% in FY19 and FY20, according to Reuters’ compilation of analyst estimates.

The recent increase in its shares have seen its price to earnings multiple increase to 29 times its FY19 estimated earnings and 26.6 times FY20 estimated earnings. That may seem low compared to its FMCG peers but may continue, till one can be confident that the worst of the policy measures and steep tax rate hikes are behind it.

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