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ITC's Q2FY20 results (Neutral) - In line quarter

Q2FY20 result highlights

• ITC’s net revenues grew by 5.3% yoy to Rs118.7bn (est: Rs120.6bn). EBITDA grew 8.5% yoy at Rs45.6bn (est: Rs46.6bn). PAT grew by strong 36.2% yoy to Rs40.3bn (est: Rs40.5bn).
• Cigarette revenues grew by 6% yoy (est: 6%). We estimate Cigarette volumes grew by ~3% yoy (est: 3%, consensus: 2-4%). Cigarette EBIT grew by 7.4% yoy (est: +7% yoy) with margin expansion of 100bps yoy to 72.2% aided by improved price/mix (and higher contribution from in-house capsules).
• FMCG sales grew by 4% yoy (adj. for sales of ‘John Players’ brand in Q4FY19, retail business sales growth would be ~6.5% which is decent given the environment). Despite higher ad-spends, EBITDA grew by 39% yoy to Rs2.2bn with a margin expansion of 170bps yoy to 6.7%.
• Hotels/Agri/Paper segment rev. grew by 17.7%/19.3%/9.9% yoy while EBIT growth for the three segments stood at 12%/5.7%/14.5%. Hotels rev growth was led by new properties, Agri growth was led by sourcing support to in-house branded packaged foods division while Paper segment growth was led by value-added paperboards.
• Hotels EBITDA was up 37% yoy but EBIT growth was lower due to D&A from newer properties; while subdued demand of tobaccos leaf and adverse mix led to just 5.7% EBIT growth in agri segment.

Key positives: Healthy EBIT margin expansion in Cigarette.

Key negatives: Muted cigarette volume, increase in working capital.

Impact on financials: Increase FY20E/21E EPS by 15%/11% led by tax cuts.

Valuations & view

ITC’s results were largely in line with 3% yoy volume growth on a base of 6%. For H2FY20E, base is unfavourable (H2FY19 cigarette volume growth at ~8%) and if H1 volume growth is anything to go by, delivering mid-single digit volume growth would be challenging. As a result, Cigarette EBIT growth is falling short of double-digit mark despite improvement in prices/mix. While regulatory environment is stable but the likelihood of punitive taxation action increases with every passing day. Revenue growth and profitability improvement in the FMCG business is on track but not enough to materially alter the PBT growth profile of 10.2% CAGR over FY19-21E. Despite cheap valuations (18x FY21E EPS) and sharp rise in earnings (due to tax cuts), we maintain Neutral rating given lack of positive triggers. In the SOTP, we lower our target multiple of cigarettes segment to 17x FY21E earnings (20x earlier) due to increasing risk of incremental taxes on Cigarettes.