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ITC Ltd’s shares were trading slightly higher in Friday’s trade on NSE, a day when the benchmark Nifty50 index was about 0.5% lower. 

The cigarette-maker’s December quarter results, announced on Thursday evening, are good to begin with.

The recovery in the cigarette business, which contributes a majority of ITC’s profits, is encouraging with the segment’s revenues rising by 13.6% year-on-year to 6244 crore on the back of easing of restrictions and increased mobility. Volume growth is reassuring. Analysts estimate the volume growth in Q3 to be in the range of 12-12.5%, back to pre-covid levels after nearly two years.

“Cigarette volume growth at about 12% was a surprise, with two-year CAGR at +2% - this is the first positive print after seven quarters and should also allay concerns on consumer behavior," said analysts from Jefferies India in a report on 3 February. CAGR is short for compound annual growth rate. Cigarette business Ebit grew by 14.4% to Rs3951 crore with margin at 63.2%.

Further, ITC’s fast-moving consumer goods (FMCG) segment too, performed well, with Q3 revenues increasing by 9.3% year-on-year (y-o-y) to Rs4,091 crore. Here, staples, convenience foods and discretionary/out-of-home categories saw robust demand whereas hygiene products witnessed moderate demand with a fall in covid-cases. High input costs weighed on margins with FMCG’s Ebit margin contracting by about 50 basis points y-o-y to 5.9%. One basis point is one-hundredth of a point.

A relatively softer base and strong growth in key segments boosted ITC’s overall profitability. The company’s standalone Ebitda (earnings before interest, tax, depreciation and amortization) rose 18% y-o-y to Rs5102 crore, exceeding Jefferies’ estimates by 8%.

The non-FMCG segments such as the agri business reported strong growth in revenue. Fewer travel restrictions, festive and holiday season, pick up in leisure travel aided the hotel segment in Q3. But the Omicron variant is likely to throw cold water on the Q4FY22 performance. Further, volumes in the paperboard business reached record high in Q3 on the back of demand revival across most end user segments and exports. The company could benefit from its focus on developing sustainable paperboard and packaging solutions with increased awareness and shift towards sustainable solutions.

Hereon, investors would keep a close eye on the impact of increased price of commodities and higher crude oil prices on FMCG margins in Q4. Plus, the slowdown in rural consumption is a big worry for FMCG companies in general.

Meanwhile, there were no tax changes on cigarettes in the Union Budget and that is a relief for ITC. But possible changes in goods and services tax (GST) rates could be discouraging in future.

Even so, going ahead, it will be in the interest of the company to reduce its dependence on the cigarette business. As pointed out by Motilal Oswal analysts, “The Cigarettes business is likely to contribute ~80% to ITC's overall EBIT even in FY23E, there is no material reduction in its dependence on this segment, which is beset by concerns of: a) weak EBIT growth for several years now, b) the overhang of a possible GST increase going forward, and c) ESG-related issues over tobacco, leading to a reduction in global valuation multiples."

These concerns seem to be taken into account by investors evident from the material underperformance of ITC's shares vis-a-vis the Nifty FMCG index in the past one year.

 

 

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