ITC - Cigarettes provide strength

ITC's EBITDA grew 13% yoy in 3Q09 despite three of its businesses reporting negative EBIT growth. Cigarette EBIT increased 17.5% in 2Q/3Q09 despite structural headwinds. Buy, with an increased target price of Rs214 (from Rs211).

The cigarette business gains momentum
ITC's cigarette business faced a significant increase in taxes in the last two years: in 2007, the tax rate increased 30% due to the implementation of VAT on the MRP of cigarettes; and, in 2008, there was a 140-390% increase due to the hike in excise duty on non-filter cigarettes. Nevertheless, cigarette EBIT growth averaged 13.4% in the last seven quarters. In 1Q09, EBIT grew only 2%, but it accelerated to 17.5% in 2Q/3Q09, reflecting an improved product mix. Volumes were hit only marginally, falling 1% in FY08 and 3.5% in FY09, though non-filter volumes were zero (19% of total volumes in FY08). Clearly, ITC's competitive position in cigarettes has improved, thanks to strong brands at all price points.

13% EBITDA growth despite negative EBIT growth in three key businesses
ITC’s 3Q09 earnings were in line with our expectations, although the loss in the other FMCG businesses exceeded our estimate, while hotels and paper EBIT disappointed. The 17.5% EBIT growth in the core cigarette business beat our estimates.

We see positive catalysts in the non-cigarettes business
Hotel EBIT declined 34% in 3Q09, due to the impact of the terrorist attack on Mumbai and the cancellation of a cricket event (for which ITC had several room bookings). While the macro environment remains weak, 3Q09 was also hit by one-off events. For paper, the full impact of the commissioning of a new paper machine and lower pulp and coal prices will be seen from 4Q09. Besides, we expect the other FMCG losses to moderate following the high launch expenses for personal-wash products.

Maintaining Buy at a target price of Rs214
We reduce FY10F EPS by 3.8% and introduce FY11F EPS. We expect EPS to grow 15% in FY09 and raise our DCF-based target price to Rs214, adjusting for changes in our risk-free rate and market risk premium assumptions.