ITC's better Q4 fails to fully convince the street; stock rises just 1%

Topics ITC | FMCG | Cigarette

ITC is currently trading at 16 times its FY21 estimated earnings versus over 35 times in case of many other FMCG players.
Besides ITC’s better-than-expected March 2020 quarter (Q4) earnings, high hopes from its non-cigarette FMCG business (staple category like Aashirvaad atta, Sunfeast brand, etc.) and higher dividend pay-out (80 per cent versus 68-69 per cent earlier) failed to encourage the street to a great extent. Therefore, despite very attractive valuations, ITC’s stock rose by just one per cent on Monday, although it was better than 0.6 per cent fall in the BSE Sensex. This was mainly for dominance of cigarette business, which is exposed to tax, regulatory and other headwinds.

The cigarette major, which announced its Q4 results on Friday last week post-market hours, is currently trading at 16 times its FY21 estimated earnings versus over 35 times in case of many other FMCG players.

In Q4, Covid-19-led disruptions led to a revenue fall across ITC’s business segments, which resulted in 6.3 per cent year-on-year fall in gross sales to Rs 11,300 crore, near to Rs 11,831.7 crore estimated by analysts as per Bloomberg poll. Its pre-tax profits declined by 8.9 per cent year-on-year to Rs 4,511.8 crore, higher than analysts’ expectations of Rs 4,454.6 crore as per Bloomberg.

While this is encouraging, analysts at Motilal Oswal say “while valuations appear inexpensive, the narrative on ITC has changed over the past year with ESG (environmental, social and governance) concerns over cigarettes increasing worldwide. Consequently, global tobacco peers have witnessed sharp contraction in their multiples.”

This is cautious given ITC’s 85 per cent of its overall operating profits coming from cigarette business and is still enjoying premium valuation over other global tobacco majors like Phillip Morris and British American Tobacco. As per Motilal Oswals’ report, these companies have a one-year forward price to earnings ratio of less than 14 times.

Additionally, there is a possibility of a further increase in taxes, which could hurt cigarette volumes. In Q4 also, besides Covid-19-led lockdowns, a steep rise in cigarette tax effective February 2020, led to around 10 per cent fall in cigarette volumes, on an estimated basis. While price hikes in February led to a lower fall in overall cigarette revenues to 6.5 per cent. The company does not reveal cigarette volume data.

Though there is a good recovery in cigarette business as the lockdown is getting lifted, some analysts are skeptical of sustaining the momentum. Vishal Gutka, vice president at Phillip Capital cautions that “recovery in cigarette business can also be attributable to shrinkage in illegal cigarette trade due to Covid-19-led travel restrictions and business disruptions being faced by key competitors (like Godfrey Phillips and VST). Thus, once they are back, maintaining good momentum in the cigarette business would be difficult for ITC.

In fact, ITC, in its press release, also said that persistent weakness in the demand environment coupled with growth in illicit cigarette trade weighed on its cigarette business performance in FY20. Further, recovery of other businesses like hotels is very tough.

Overall, despite higher dividend pay-out and strong free cash flows, cigarette dominance is likely to weigh investor sentiment. Some also believes, once the FY20 dividend is paid, the stock could again see some corrections. The jury is out on this.

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