ITC - Worst appears to be past

ITC's 4% drop in 1Q09 PAT was driven by weaker profit growth in cigarettes and losses in the FMCG business. There have certain one-off expenses in the cigarettes business, and thes migration from non-filters to filters has been strong. Upgrade to Buy.

FY1Q09 results were below our expectations
ITC reported a flat yoy EBITDA and a 4% drop in PAT. While its hotel, agri and paper businesses performed well, the higher losses in its FMCG businesses and lower EBIT growth in its core cigarette business impacted overall growth.

Performance of core cigarette business should improve through FY09
ITC reported a weak EBIT growth of 2.4% in 1Q as margins slipped by 90bps yoy. Owing to the discontinuation of the non-filter cigarette business, ITC has been proactive in the marketplace to drive migration of its consumers from non-filter cigarettes to filters. We believe this will result in an extraordinary, nonrecurring cost. ITC has also begun increasing prices of its key brands in the last few weeks, which should favourably impact its cigarette business for rest of the year. For FY09, we expect a 8.9% EBIT growth, improving further to 13% in FY10.

ITC's other FMCG businesses are reducing EBIT by 8%
ITC is currently focusing on creating brands in its other FMCG businesses. In food segments, its brands 'Aashirvaad' and 'Sunfeast' have become dominant in the staples and biscuits segments, respectively. It has now turned its attention to the snacking ( 'Bingo' brand) and personal care segments ( 'Vivek' and 'Fiama Di Wills'). Post the initial gestation period, ITC's other non-cigarette businesses like paper and hotels have become self-sustaining in terms of cash required to drive business growth. By the end of FY09, we believe the losses in the FMCG businesses will have peaked, and ITC's focus on brands in its other FMCG business should start positively impacting profits thereafter.

We upgrade to Buy. Earnings momentum should be back in FY2H09
We have marginally cut our EPS estimates for FY09 by 3% but retain our FY10 EPS estimates post the FY1Q09 results. The stock has corrected 10% since its budget announcement in early March 2008, and we believe most of the concerns on FY09 earnings are already reflected in the price. We marginally upgrade our DCF-based target price to Rs211 and upgrade the stock to Buy.