ITC: Stellar 26% YTD Return Makes It A Hold

ITC reported good 1Q FY13 performance with in-line sales and better-than expected earnings. Net sales, EBITDA and PAT witnessed growth of 15%, 23% and 20% respectively. Robust cigarette EBIT growth led by pricing was the key earnings driver. We believe ITC should remain a core long-term holding given steady cigarette EBIT growth, improving profitability of other FMCG business, high FCF generation and potential for higher dividend payout. The stock has run up 26% YTD (trading close to the high end of its historical valuation band) and we would seek better entry points. In current uncertain markets, however, we see it as one of the better defensive holdings.

– Pricing continues to drive healthy cigarette EBIT growth. ITC reported 15% cigarette sales growth led entirely by pricing and estimated flat volume growth (better than our estimates). Pricing benefits and operating leverage aided margin expansion of 140bp y/y for cigarettes leading to robust 20% EBIT growth.

We expect volume sluggishness to continue in the near term as consumers accommodate steep price increases made since Mar’12. We believe pricing will continue to support mid-to-high-teen EBIT growth for cigarettes over the medium term – we estimate 17% cigarette EBIT CAGR over FY12-14. ITC has rolled out cigarettes with 64mm length at price points of Rs2-2.5/stick in some states (in test phase) and we would expect clear strategy on this front to pan out over next few months.

– Other FMCG continues to register healthy sales growth and reduction in losses. Sales growth of 23% and losses declined 49% y/y driven by better scale, price/mix growth and improved profitability across foods, stationary and personal care segments. We expect this trend to continue and expect other FMCG division to turn around in FY14 on profitability front.

– Moderate growth for hotels and agri business; Paper EBIT grows well.

While the hotel division continues with disappointing performance owing to macro headwinds (sales up +1%, EBIT –49%), agri business had a subdued quarter (sales –1%, EBIT +9%) owing to lower demand and muted pricing for leaf tobacco exports. Paper business however benefited from better mix leading to 17% EBIT growth.