Neutral ITC, target Rs 310: Motilal Oswal Securities
ITC is a largecap company, operating mainly in tobacco sector.
Shares of ITC traded at Rs 276.2 around 3 pm on 24 June, 2019. The brokerage has set a one-year horizon for the stock to hit the target price.
ITC’s cigarette business’ contribution to revenues has been steadily declining over the years (now stands at nearly 41 per cent, excluding eliminations), but it accounts for the lion’s share in profits generated by the company with Ebit contribution of 85 per cent.
Notably, Ebit contribution from the cigarette business has remained at 85-86 per cent in the last five years. Also, the FMCG (Others) business has ramped up well, growing at 10.5 per cent with segment Ebit almost doubling in FY19 (nearly 2 per cent of total EBIT).
However, it will take a few more years for the segment to contribute meaningfully to the company’s profits, the brokerage said.
The year saw an investment of nearly Rs 2,760 crore across businesses. An investment outlay of Rs 2,500 crore has been envisaged to support creation of several Integrated Consumer Goods Manufacturing & Logistics facilities (ICMLs) for its FMCG businesses, to build iconic luxury hotels and to strengthen distribution and the agri-backend.
A major portion of incremental capex remains towards the FMCG-Others business segment with FY19 seeing capex of Rs 1,320 crore.
During the year, the company executed more than 50 new product launches across geographies, apart from extending distribution reach of several existing products in the portfolio.
Currently, ITC’s distribution network directly and indirectly covers over 60 lakh retail outlets across various trade channels.
Net Working Capital Days decreased by 5 days and now stands at 57 days (calculated on average basis), driven by improvement in raw material and finished goods inventory.
Free cash flow (FCF) for ITC remained healthy in FY19 (Rs 9,000 crore), but saw a decline of 11 per cent YoY as benefits of higher payable days seen in FY18 was absent this year.
Return ratios improved slightly in FY19 (RoE stood at 22.8 per cent against 22.3 per cent in FY18 and RoCE inched up to 22.1 per cent against 21.6 per cent in FY18).
"Even after 23 months since the last GST hike, Cigarette Ebit growth remains below 10 per cent. Moreover, our moderate 9.3 per cent earnings CAGR (FY19-21) estimate has a downside risk if the GST Council increases the rates applicable to cigarettes in its subsequent meetings. An increase in the ad valorem duty would sour the investment case further," the brokerage said.
The brokerage believes that ‘more the delay, more the risk’ of a sharp tax rate increase, which would eventually exert significant pressure on volumes.
Despite favorable environment in FY19, cigarette Ebit grew only 9.1 per cent.
While ITC trades at a discount to Indian FMCG peers at 22.7 times FY21E EPS, it is at a premium to global cigarette majors (1.5 times-2.5 times).
"Due to the uncertain cigarette earnings outlook (accounts for 85 per cent of Ebit), we maintain neutral rating with a target price of Rs 310 (25 times June 2021E EPS)," said the brokerage.