ITC investors fume over slower growth in Oct-Dec quarter, higher taxes

Topics ITC | ITC Q3 results

ITC, which is known to not only bounce back stronger from adverse situations but also take on the might of large multinationals, is once again being put to test. It is not only the slower growth for the December quarter (Q3) that indicates near-term pressure for the company; there are headwinds that cloud ITC’s medium-term prospects as well.

Investor concerns are not without reason, considering the cigarette business accounted for 84.7 per cent of ITC’s consolidated earnings before interest and tax (Ebit) in 2018-19.

In Q3, too, the company posted a mere 5.7 per cent increase in consolidated revenue, with the cigarette business growing just 5.3 per cent, over the year-ago period. Standalone revenue growth at 5 per cent is the lowest in seven quarters. Worse, operating profit (excluding other income) also grew by just 5.2 per cent on a consolidated basis; 3.6 per cent for standalone entity (the slowest increase in 12 quarters).

After results, five analysts have downgraded the stock, while one has upped her rating. Of the 25 analysts polled by Bloomberg, 16 have a ‘buy’, 8 a ‘hold’ and one a ‘reduce’ rating of ITC, and their average target price is Rs 279.28.

Even the promising FMCG (consumer products excluding cigarettes) business clocked a muted growth of 3.5 per cent year-on-year (YoY). In spite of the slowdown, investments in brand building and gestation costs of new categories also reflect in the financial results of the FMCG segment.

The company, however, has been able to push up margins in both cigarette and FMCG businesses, given their profit has grown ahead of the top line. Consolidated Ebit of the cigarette business, for instance, was up 6.5 per cent YoY in Q3, partly aided by price hikes, while the same for FMCG was up 36.5 per cent, helped by measures to improve profitability and a low base.

If slowdown in financial performance wasn’t enough, the Union Budget has dealt a blow to the cigarette business by raising taxes in an unorthodox way.

Richard Liu and Vicky Punjabi of JM Financial, in a February 1 note, said, “In a rather shocking move, the government effectively hiked cigarette taxes by 13-14 per cent. A part ad-valorem GST tax structure necessitates that part of price hikes (to pass on the higher taxes) gets shared with the government, resulting in much higher effective increase in taxes versus what the FM announced.”

The hike in taxes is expected to hurt ITC’s earnings. Ashit Desai of Emkay Global Research said in a note on Sunday, “Based on our workings, the hike in cigarette duties is likely to result in a weighted average consumer price increase of 6-7 per cent for ITC, with price increases being higher at Rs 8 per cent in 64 mm cigarettes.”

The move comes at a time when cigarette demand is already under pressure. “A weak demand scenario, high base, and rising salience of illegal cigarettes at the premium end constrained cigarette volume growth to 2 per cent YoY (base of 7.5 per cent YoY), in line with our estimate,” said Edelweiss’ analysts led by Abneesh Roy.

Not surprising then, ITC’s stock has been a significant underperformer vis-à-vis Hindustan Unilever as well as the BSE Sensex in nearly the last two years.

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