BUY - HDFC securities - Update - Sep18... · 2018. 9. 19. · BUY . HDFC securities Institutional Research is also available on Bloomberg HSLB & Thomson Reuters . Time to

COMPANY UPDATE 19 SEP 2018

ITC BUY

HDFC securities Institutional Research is also available on Bloomberg HSLB <GO>& Thomson Reuters

Time to reconsider Time and time again the concern on ITC has been around tax hikes and its impact on the cigarette business. All challenges aside, the company has been able to deliver ~10% cigarette revenue CAGR in the last 10 years (in comparison to FMCG sector growing by 13%) despite muted volume growth. This reflects ITC’s pricing power and leadership position. With this note we tried to answer critics who believe that cigarette industry volumes have ‘peaked’ in India. To gain some perspective, we compared Indian cigarette market with global market. India is a ‘unique’ market wherein 85% tobacco consumption is from non-cigarette products vs. 10% globally. Interestingly, tobacco consumers are more prevalent in India (30% population >15yrs) vs. globally (~21% >15yrs). While, only 4% of India’s population (>15yrs) consume cigarettes. As a result, India contributes a mere 2% of global cigarette volumes (5,500bn sticks) despite housing 2nd largest smoking population in the world (skewed towards bidis). As India aggressively followed global curbing measures on cigarette smoking (despite its low share in tobacco), legal volumes declined by ~20% from its peak of FY12. During this period, illegal cigarette market in India (25% now vs. 16% in 2010) thrived on this arbitrage opportunity and surpassed global illegal share of 10%. In the backdrop of these demographics, we believe that cigarette volumes will recover hereon driven by (1) Improving consumer sentiments, (2) Recovery in rural consumption (upgrade from bidi to mini cig.) which forms 2/3rd volume share, (3) Improving standard of living, (4) Stable tax environment and (5) Curbing illicit trade (driven by WHO treaty). Our thesis is based on the assumption that tax hikes (price hike not more than general inflation)

will not be as steep as witnessed in the last 5 years. In such a scenario, ITC can deliver mid single digit volume growth during FY18-21E. Non-cigarette business is in a sweet spot: ITC in its

packaged food portfolio has successfully built power brands like Aashirvaad, Sunfeast and Bingo. Its strength lies in backward integration, large appetite to spend on brand investments and pan-India distribution. With improving consumption dynamics, ITC can scale its existing portfolio (a 13x opportunity) through several brand extensions and enter in newer categories. We believe ITC’s strategy will also be around profitable growth after achieving a meaningful scale. Other non-cigarette segments (Hotels, Paper and Agri) are also on the verge of posting improved performance. We expect overall non-cigarette business to grow by 14% CAGR during FY18-21E.

At 27x FY20E EPS, ITC trades at an unfair discount of ~30% to the sector. We roll forward to Sep-20E EPS, valuing at 32x with TP of Rs 382 (earlier Rs 367). Maintain BUY.

Financial Summary (Rs mn) FY17 FY18 FY19E FY20E FY21E

Net Revenue 428,036 434,489 477,099 528,138 586,676

EBITDA 154,359 164,830 182,299 201,389 224,654

APAT 104,772 112,202 124,565 137,819 153,880

EPS (Rs) 8.6 9.2 10.2 11.3 12.6

P/E (x) 35.0 32.8 29.6 26.7 24.0

EV/EBITDA (x) 22.4 20.8 18.8 16.8 14.9

Core RoCE (%) 36.4 37.2 37.6 38.1 40.3 Source: Company, HDFC sec Inst Research

INDUSTRY FMCG

CMP (as on 27 Jul 2017) Rs 289

Target Price Rs 353

Nifty 10,021

Sensex 32,383

KEY STOCK DATA Bloomberg ITC IN

No. of Shares (mn) 12,161

MCap (Rs bn)/(US$ mn) 3,509/54,743

6m avg traded value (Rs mn) 4,144

STOCK PERFORMANCE (%)

52 Week high / low Rs 368 / 222

3M 6M 12M

Absolute (%) 1.0 12.1 16.6

Relative (%) (6.9) (4.0) 1.1

SHAREHOLDING PATTERN (%)

Promoters 67.20

FIs & Local MFs 5.19

FPIs 13.79

Public & Others 13.82 Source : BSE

Naveen Trivedi [email protected] +91-22-6171-7324

INDUSTRY FMCG

CMP (as on 18 Sep 2018) Rs 303

Target Price Rs 382

Nifty 11,279

Sensex 37,291

KEY STOCK DATA Bloomberg ITC IN

No. of Shares (mn) 12,230

MCap (Rs bn)/(US$ mn) 3,709/50,952

6m avg traded value (Rs mn) 3,404

STOCK PERFORMANCE (%)

52 Week high / low Rs 323 / 250

3M 6M 12M

Absolute (%) 14.6 16.4 13.6

Relative (%) 9.7 4.0 (1.4)

SHAREHOLDING PATTERN (%)

Promoters 0

FIs & Local MFs 36.68

FPIs 18.63

Public & Others 44.69 Source : BSE

Naveen Trivedi [email protected] +91-22-6171-7324

Siddhant Chhabria [email protected] +91-22-6171-7336

mailto:[email protected]

ITC: COMPANY UPDATE

Page | 2

Table of Content World Cigarette Consumption: Is India really comparable? ...................................................................................... pg 3 Global smokers: India ranks 2nd in terms of daily smokers World consumes 5,500bn cigarettes/year: India contributes a mere ~2% World per capita cigarette consumption: Indian smokers prefer bidis over cigarettes

India’s mix of tobacco smokers: Bidi dominates with 74% share of smokers World tobacco consumption mix: India consumes only 15% of tobacco in the form of cigarettes India’s tobacco consumers: Dominated by smokeless tobacco (Khaini, gutka and paan masala) users Global tobacco smoking mapping: Have cigarette smokers really peaked in India? World illegal cigarette share: Steep tax rise has incentivized arbitrage of illicit trade Country-wise illegal cigarette share: India illegal share higher than world average

India Cigarette Market: A unique market .................................................................................................................. pg7 Bidi and Cigarette Market: Bidi volumes are 4x of cigarette while retail market value is only at 0.2x

India’s mix of tobacco and non-tobacco users Breakup of tobacco users Tobacco consumption is higher in rural areas Bidi dominates smoked tobacco market in rural areas; lucrative market to upgrade to cigarettes Cigarette consumption by age: With age, density of smokers and volumes/day rises Population mix of India: Higher consumers of cigarette (>24 years) will have higher share Tobacco consumption vs. tax collection: Cigarette has high skew towards tax despite low consumption Total tax vs. cig. tax collection: Dependence on cigarette tax collection has declined in recent years India’s cigarette market performance: Illicit trade impacted legal volumes India illegal cigarette trend: Illegal cigarette market growing in contrast to legal market Tobacco production is highly remunerative GST council may look at the bigger picture India became the 37th party to ratify ‘WHO FCTC Protocol’ on curbing illicit trade Cigarette tax increase and India’s fiscal deficit ITC Cigarette: Worst is now behind ......................................................................................................................... pg12 FMCG: Growth is value accretive ............................................................................................................................ pg15 Hotels: Pursuing an ‘asset right’ strategy ................................................................................................................. pg19 Paper: On the path to recovery ............................................................................................................................... pg21 Agri business: A volatile business ............................................................................................................................ pg22 Capital Allocation: Prudent allocation ...................................................................................................................... pg23 ITC’s Recent Performance........................................................................................................................................ pg24 Assumptions ........................................................................................................................................................... pg27

ITC: COMPANY UPDATE

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World Cigarette Consumption: Is India really comparable? We believe Indian cigarette consumption pattern is not comparable with global trends. Therefore, harsh to predict that India’s cigarette consumption will decline in tandem with developed nations. Here’s why:

World market vs. India

Globally cigarette forms 90% of tobacco consumption vs. India’s 15% (including 4% by illegal cigarette)

Global cigarette volumes stand at 5,500bn sticks, while India consumes only ~100bn sticks (including illegal). World per capita cigarette consumption is at 1,000 cigarettes vs. India at only 86 cigarettes

India houses the 2nd largest smokers in the world at ~100mn users, skewed towards bidi smokers (78mn)

Globally cigarette smokers have declined from 23.5% adult population aged >15 years old to 20.7% in 2015. However population growth during this period has led to no change in absolute number of smokers (1.1bn smokers). Also majority of the decline in smokers has come from high-income countries driven by punitive taxes coupled with awareness campaigns. In contrast, Indian tobacco consumers are at ~30% of population (>15years) with cigarette smokers at only 4%

World per capita cigarette consumption is at 1,000 cigarettes vs. India at only 86 cigarettes

Consistent tax increase (steep in last 5 years) led to Indian cigarette becoming the most expensive in the world on PPP basis

Global illegal cigarette market contributes ~10% of volumes vs. India at 25% (16% in 2010)

Globally an avg. smoker consumes ~14 cigarettes/day vs. ~7 cigarettes in India

ITC: COMPANY UPDATE

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Global smokers: India ranks 2nd in terms of daily smokers

World consumes 5,500bn cigarettes/year: India contributes a mere ~2% of volumes

Source: IHME, GBD 2015 Tobacco Collaborators, HDFC sec Inst Research

Source: Tobacco-Free Kids (Euromonitor International 2017), HDFC sec Inst Research

World per capita cigarette consumption: Indian smokers opt for bidis over cigarettes

India’s mix of tobacco smokers: Bidi dominates with 74% share of smokers

Source: The Tobacco Atlas – 4th Edition (American Cancer Society), HDFC sec Inst Research

Source: Global Adult Tobacco Survey 2016-17, HDFC sec Inst Research

World-wide population for smoking has declined from 23.5% in 2007 to 20.7% in 2015. However, the population for smokers are steady at ~1.1bn owing to population growth India houses the 2nd largest smokers in the world at ~100mn users, skewed towards bidi smokers (78mn)

Globally an avg. smoker consumes ~14 cigarettes/day vs. ~7 cigarettes in India

0 70 140 210 280

ChinaIndia

IndonesiaUSA

RussiaBangladesh

JapanBrazil

GermanyPhilippines

Male Female(mn no.)2,351

316 278 263 174 106 90 86 85 79 -

500

1,000

1,500

2,000

2,500

Chin

a

Indo

nesia

Russ

ia

USA

Japa

n

Turk

ey

Egyp

t

Bang

lade

sh

Indi

a

Phili

ppin

es

(bn sticks)

2,786

1,841 1,711

1,028 865

468 420 154 96

-

1,000

2,000

3,000

Russ

ia

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a

USA

Wor

ld A

vg.

Paki

stan

Nepa

l

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(No . of sticks)

Cigarette26%

Bidi74%

ITC: COMPANY UPDATE

Page | 5

World tobacco consumption mix: India consumes only 15% of tobacco in the form of cigarettes

India’s tobacco consumers: Dominated by smokeless tobacco (Khaini, gutka and paan masala) users

Source: USDA; Tobacco Board, HDFC sec Inst Research Source: Global Adult Tobacco Survey 2016-17, HDFC sec Inst Research

Global tobacco smoking mapping: Have cigarette smokers really peaked in India? Current tobacco smoking (>15 Yr) Tax as a % of

retail price Retail Price of pack of

20 cig (as per PPP) Male (+15 Yr) Female (+15 Yr) Overall High income (56 countries) 29% 18% 23% 65% $7.2

Australia 19% 13% 16% 60% $14.9 UK 25% 20% 22% 81% $12.0 USA 22% 15% 19% 43% $6.4 Japan 30% 8% 18% 63% $4.3 Germany 33% 28% 31% $7.6

Middle income (106 countries) 37% 4% 21% 55% $4.3 India (Cigarette + Bidi) 19% 2% 11% na na India (Cigarette) 7% 1% 4% ~56% $9.2 China 52% 3% 28% 51% $2.8 Russia 58% 23% 41% 51% $4.6 Pakistan 22% 2% 12% 60% $2.2 Bangladesh 55% 1% 26% 77% $3.4

Low income (31 countries) 23% 3% 13% 37% $3.1 Nepal 27% 10% 19% 26% $5.7 Ethiopia 9% 0% 5% 19% $1.8 Zimbabwe 31% 2% 16% 36% $3.5 Uganda 17% 3% 10% 51% $2.4

World 35% 6% 21% 56% $4.9 Source: WHO Global Tobacco Epidemic, HDFC sec Inst Research

Out of 15% of tobacco consumption in the form of cigarette, legal cigarette contributes 11% Tobacco consumers are ~21% of world population (> 15 years) comprising of 1,100mn smokers vs. India at ~29% with 267mn smokers Despite a large population base of tobacco consumers in India, Cigarette smokers stand at only 4% of population >15 years old India has a low cigarette smoking population at 4% vs. world average of 21% Despite 11% of smoking population, India ranks low on cigarette smokers (4% of pop.) due to low affordability of cig and cheap availability of bidis India’s tax as % of retail price stands at par with the world average, therefore we do not expect aggressive tax hikes hereon

267

200

72 37

-

50

100

150

200

250

300

Tobacco users

Smokeless tobacco

Bidi smokers Cigarette smokers

%(mn users )

90%

15%

10%

85%

0%

20%

40%

60%

80%

100%

World India

Cigarette Others (Bidi, Smokeless Tobacco)

ITC: COMPANY UPDATE

Page | 6

World illegal cigarette share: Steep tax rise has incentivized arbitrage of illicit trade

Country-wise illegal cigarette share: India’s illegal share (25%) is higher than world average (~10%)

Source: TII Tobacco, CDC USA (Euromonitor), Company, HDFC sec Inst Research

Source: TII Tobacco, CDC USA (Euromonitor), Company, HDFC sec Inst Research Note: India and Malaysia are current data

Global illegal cigarette market contributes ~10% of volumes vs. India at 25% (16% in 2010)

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

Japa

n

Russ

ia

Aust

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USA

Ger

man

y

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8%10%

16%

25%

0%

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20%

30%

2011 2017

World India

ITC: COMPANY UPDATE

Page | 7

India Cigarette Market: A unique market India is a unique cigarette market, cigarette forms only 15% of tobacco consumption (inc. 4% illegal) vs. 90% globally

In India, ~29% of the population (>15 years) are tobacco consumers while only 4% are cigarette consumers In India, legal cigarette contributes only 11% of tobacco consumption while contributes 87% of tax collection Legal cigarette market has contracted by 5% CAGR during 2011-17 while illegal market grew by 5% during the same

period In India, rural cigarette smokers are 2x of urban smokers which is in line with population mix Cigarette consumption rises with age in terms of: (1) cigarettes/day and (2) Density of smoking population. As India

ages, we believe demographics will continue to be favorable for consumption India’s measures (pictorial warnings, ban of public smoking, high taxes, etc) towards controlling cigarette consumption

are at par with global standards. In contrast, curbing non-cigarette consumption has been ignored by the govt. Bidi and Cigarette Market: Bidi volumes are 4x of cigarette while retail market value is only at 0.2x

Bidi Cigarette Total Bidi/Cig (x) Smokers (mn) 72 37 109 1.9x Units/day (sticks per smoker) 15 7 12 2.1x Annual volumes (bn sticks) 396 100 496 4.0x Est. Retail Mkt Size (Rs bn) 198 1,000 1,198 0.2x Source: HDFC sec Inst Research India’s mix of tobacco and non-tobacco users Breakup of tobacco users



State-wise tobacco consumption (% of population >15 years)

Source: Global Adult Tobacco Survey 2017

0% 20% 40% 60% 80%

Tripura

Mizoram

Manipur

Assam

Meghalaya

Odisha

Arunachal Pradesh

Nagaland

Chhattisgarh

Jharkhand

Uttar Pradesh

Madhya Pradesh

West Bengal

India

Maharashtra

Uttarakhand

Bihar

Gujarat

Rajasthan

Jammu & Kashmir

Haryana

Karnataka

Andhra Pradesh

Tamil Nadu

Sikkim

Delhi

Telangana

Himachal Pradesh

Chandigarh

Punjab

Kerala

Puducherry

Goa

Smoked only Smokeless only Both

71% (666mn)

29% (267mn)

Non-tobacco users Tobacco users

% of population >15 years old

65% (200mn)

23% (72mn)

12% (37mn)

Smokeless tobacco Bidi smokers Cigarette smokers


ITC: COMPANY UPDATE

Page | 8

Tobacco consumption is higher in rural areas Bidi dominates smoked tobacco market in rural areas; lucrative market to upgrade to cigarettes



Cigarette consumption by age: With age, density of smokers and volumes/day rises

Population mix of India: Mix will shift towards age groups of higher consumers of cigarette (>24 years)


Source: Office of the Registrar – India, World Bank, HDFC sec Inst Research

5.1

6.87.4

6.5

1.8%

4.1% 4.1%3.7%

0%

1%

2%

3%

4%

5%

3.0

4.0

5.0

6.0

7.0

8.0

15-24 Yr 25-44 Yr 45-64 Yr >65 Yr

Avg. cigarettes/day % of cig. smokers - RHS

0%

5%

10%

15%

20%

25%

30%

35%

<15 Yr 15-24 Yr 25-44 Yr 45-64 Yr >65 Yr

2001 2011 2021E 2031EAge mix (%)

Despite similar share of cigarette users (~4%) reside in urban and rural areas, absolute cigarette smokers are higher in rural areas (~2x of urban) Cigarettes taxes are 51 times higher than other tobacco products

Source: Ministry of Finance, Govt. of India; Industry Estimates. HDFC sec Inst Research

4,159

81 -

900

1,800

2,700

3,600

4,500

Cigarette Other tobacco products

(Rs/Kg)

11.1 13.6

17.3

26.64.2

7.3

0

10

20

30

40

50

Urban Rural

Smoked only Smokeless only Both


4.4 3.8

4.79.3

0

2

4

6

8

10

12

14

Urban Rural

Cigarette Bidi% of population >15 years old

ITC: COMPANY UPDATE

Page | 9

Tobacco consumption vs. tax collection: Cigarette has high skew towards tax despite low consumption

Total tax vs. cig. tax collection: Dependence on cigarette tax collection has declined in recent years

Source: Ministry of finance, TII Board, HDFC sec Inst Research Source: NIC, TII, Economic Survey, HDFC sec Inst Research, HDFC sec Inst Research

India’s cigarette market performance: Illicit trade impacted legal volumes

India illegal cigarette trend: Illegal cigarette market growing in contrast to legal market

Source: TII Tobacco, HDFC sec Inst Research Source: TII Tobacco, HDFC sec Inst Research

11%4%

85%87%

0%

13%

0%

25%

50%

75%

100%

LegalCigarettes

IllegalCigarettes

Other TobaccoProducts

Share of Tobacco Consumption Share of Tax Revenue

1.5%

1.6%

1.7%

1.8%

1.9%

2.0%

2.1%

2.2%

-

50

100

150

200

250

300

350

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

FY17

FY18

Tax collection from Cig. (Rs bn)Cig. Tax (% Total Tax) - RHS

Cigarette contributes 11% of tobacco consumption while tax contribution is very high at 87% Consistent lowering down the dependence on cigarette tax collection in the overall tax collection suggests less sensitive to Robust tax collections in India and muted legal cigarette volume growth led to lower dependence on tax collection from cigarettes Legal cigarette market has contracted by 5% CAGR during 2011-17 while illegal market grew by 5% during the same period

1113

1415

17 18 1820

2122

2324

25 26

6

12

18

24

30

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

(Bn units)

102

20

122

77

26

103

-

20

40

60

80

100

120

140

Legal Cig Illegal Cig Total

2011 2017

-5% CAGR

5% CAGR

-3% CAGR

(Bn units)

ITC: COMPANY UPDATE

Page | 10

Tobacco production is highly remunerative India is the world’s 2nd largest producer of tobacco.

Tobacco is grown in poor and marginal soils that are unsuitable for cultivation of other crops. It is a labor intensive crop and highly remunerative crop providing higher returns vs. other crops in the region. Considering government’s impetus towards driving the rural economy by creating jobs (focus on labor intensive sectors) we don’t foresee the government raising cigarette taxes to such an extent that will impact tobacco farmers.

No sustainable alternative to FCV (Cigarette) tobacco Crop (Rs/Hectare) Andhra Pradesh Karnataka FCV – Light Soils 33,061 31,226 FCV – Black Soils 19,539 - Cotton 2,906 22,380 Maize 4,576 15,394 Bengal Gram 9,325 - Source: Tobacco institute of India, HDFC sec Inst Research

GST council may look at the bigger picture We believe the council’s approach towards tax hikes

on cigarette will be on overall tax collection rather than state specific matters (erstwhile regime). In other words, they will hike taxes on cigarette in such a manner that will not deter their tax collections. It is estimated that the government loses out on Rs 130bn (vs. ~Rs 340bn tobacco tax collection) annually owing to the ballooning of the illegal market.

India became the 37th party to ratify ‘WHO FCTC Protocol’ on curbing illicit trade What is the Protocol: The Indian government, in

May-18, has approved the protocol under WHO Framework Convention on Tobacco Control (FCTC) to eliminate illicit trade in tobacco products. It will be applicable to both smoking and smokeless tobacco forms. The Protocol is the first international treaty negotiated and adopted by the Parties to the WHO FCTC and its entry into force represents an important step in the fight against the illicit trade in tobacco products. This new treaty provides new legal dimensions for international cooperation beyond the health sector.

How the protocol works? The Protocol contains a full range of measures to curb illicit trade in three categories: (1) Preventing illicit trade, (2) Promoting law enforcement and (3) Providing the legal basis for international cooperation. It has measures to secure the supply chain of tobacco products, such as through licensing, record keeping and a global tracking and tracing regime.

We believe such actions can result in curbing the illicit cigarette market which have impacted the legal industry.

India is the world’s 2nd largest producer of tobacco Tobacco is a labour intensive crop and highly remunerative vs. other crops GST council may look at the bigger picture

ITC: COMPANY UPDATE

Page | 11

Historically higher fiscal deficit does not imply increase in cigarette taxes: India's fiscal deficit was very high at 6%, 6.5%, 4.8% and 5.9% between FY09-12, respectively. However, Govt. had increased the

taxes on cigarettes only once during those 4 years. Even if govt. prepares a populist budget for FY19, we believe India's fiscal deficit currently is healthy and not alarming as compared to the historical highs.

Cigarette tax increase and India’s fiscal deficit

Particulars FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 (GST) Fiscal Deficit 6.0% 6.5% 4.8% 5.9% 4.9% 4.5% 4.0% 3.9% 3.5% 3.5% Cigarette Excise Increase Length <65mm (DSFT) 0% 0% 0% 72% 25% 10%

GST implementation

Length 65-70mm (Regular) 0% 0% 18% 0% 23% 18% 17% 15% 10% Length 70-75mm (Long) 0% 0% 11% 0% 17% 18% 11% 15% 10% Length >75mm (King) 0% 0% 11% 0% 18% 18% 21% 14% 11% Effective tax increase (%) 0% 0% 16% 0% 22% 18% 20% 19% 10% 20%

Particulars (Rs bn) FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 Tax collection from Cig. (Rs bn) 122 128 153 176 218 235 258 278 285 299 Indirect Tax Collection 2,830 2,475 3,478 3,960 4,731 5,012 5,467 7,148 8,663 9,411 Direct Tax Collection 3,338 3,770 4,453 4,932 5,650 6,375 7,047 7,408 8,495 10,050 Total Tax Collection 6,168 6,245 7,931 8,892 10,380 11,387 12,514 14,556 17,158 19,461 % Growth 1% 27% 12% 17% 10% 10% 16% 18% 13% Cigarette Tax (% Indirect Tax) 4.3% 5.2% 4.4% 4.4% 4.6% 4.7% 4.7% 3.9% 3.3% 3.2% Cig. Tax (% Total Tax) 2.0% 2.1% 1.9% 2.0% 2.1% 2.1% 2.1% 1.9% 1.7% 1.5% Source: NIC, TII, Economic Survey, HDFC sec Inst Research

India's fiscal deficit was very high at 6%, 6.5%, 4.8% and 5.9% between FY09-12, respectively. However, govt. had increased the taxes on cigarettes only once during those 4 years The dependence on tax revenues from cigarettes have declined over the years to ~1.5% in FY18

ITC: COMPANY UPDATE

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ITC Cigarette: Worst is now behind Remarkable 9% revenue CAGR despite muted

volume growth: Impacted by punitive taxes, volume growth has been muted during FY01-18. Even then, ITC has been able to deliver 9% cigarette revenue CAGR owing to strong pricing power. Cigarette volume’s are down by ~20% from its peak in FY12 owing to the ballooning of illegal cigarette market driven by steep tax hike (25% now vs. 10% earlier).

14% EBIT CAGR driven by pricing power: Over the years, ITC has more than passed on tax increase coupled with richer mix leading to EBIT growing faster than revenues.

Regaining market share for King size: Post the sharp increase in taxes (July’17), ITC immediately passed on the tax burden but Marlboro (Godfrey Phillips) tactically held back the price hike for ~8months. During this period, ITC lost market share to Marlboro in King Size segment. As it was not a sustainable move, Marlboro started raising prices during Jan-Mar’18 and since then ITC started regaining its lost market share.

Healthy demand from switch cigarette: Our channel checks suggesting that switch cigarette (option of mint) are witnessing strong demand. Switch option is available in King/Regular size cigarette of ITC (not available in mini).

Indian cigarette market is not comparable vs. world market: We believe the cigarette market in India is unique given the high consumption of smokeless tobacco and bidis. Hence, we don’t believe that Indian cigarette consumption will decline in tandem with global trends. Instead, we believe with improving disposable income bidi smokers will upgrade to cigarettes.

India ranks high on implementing regulatory norms: India has already implemented majority of the regulatory norms (particularly in recent years)

prevalent globally to curb cigarette consumption like pictorial warnings, ban in public places, general awareness campaigns and punitive taxation policy. Hereon, we don’t see any incremental policy to further curb smoking.

Improving rural consumption to drive upgrade: Rural forms a large share of tobacco consumption with ~2/3rd of Cigarette volumes and ~4/5th of bidi volumes in India. Since 2014 rural consumption has been challenged. We are now witnessing a broad-based recovery driven by govt’s impetus to boost rural incomes coupled with normal monsoon. In such a scenario we believe smokers will upgrade from bidis to cigarettes. Mini cigarettes (64mm @ Rs 49/10sticks) were launched in 2013 to play this upgrade. However, the launch coincided with rural economy struggling.

Better tax compliance: Legal cigarette contributes ~11% of tobacco consumption while it contributes ~87% of total tax collection from tobacco. Other forms of tobacco consumption (bidi and non-smoke) are largely avoiding paying taxes and are out of the purview of legal system. India’s better tax compliance (especially post efficient GST implementation) will also impact on the non-cigarette tobacco players. This can also potentially drive the cigarette consumption (low price gap with bidi).

Cigarette volume growth to return: Our structural take on cigarette market is that the tax increase will not be as sharp on cigarette in the coming years as it was in the last 5 years. Cigarette is more demographic favoring product (sophisticated, women friendly, status symbol) vs. bidi/non-smoked products. With moderate tax increase (should not result in price hike more than general inflation), improving consumption dynamics and control on illegal trade, the cigarette category can deliver 3-5% volume growth. In such a scenario, legal cigarette market would be able to regain its lost share.

ITC: COMPANY UPDATE

Page | 13

ITC Cigarette Gross Revenue: Despite punitive taxes, cigarette business grew by 9% CAGR during FY01-18

ITC Cigarette Volume: Volumes are down by 20% from its peak in FY12

Source: Company, HDFC sec Inst Research Note: FY01-FY17 is gross of excise and other taxes while FY18-21E is gross of GST and other taxes

Source: Company, HDFC sec Inst Research

ITC Cigarette EBIT: Strong pricing power resulted in healthy 14% EBIT growth during FY01-18

ITC Cigarette EBIT/stick: Consistent increase in EBIT per stick shows ITC’s excellence in the business

Source: Company, HDFC sec Inst Research Source: Company, HDFC sec Inst Research

77

80

88

92

100 113 128

138

151 17

3 198 22

2 260 29

1 305 32

3 340 35

7 386 41

8 452

-

130

260

390

520

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

FY17

PFY

18P

FY19

EFY

20E

FY21

E

(Rs bn)

66

61 63

65 70

76 81

81

78

84

82

84

85

83

75

69

70

68 71

73

75

-

20

40

60

80

100

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

PFY

13P

FY14

PFY

15P

FY16

PFY

17P

FY18

PFY

19E

FY20

EFY

21E

(bn stick)

17

19

20

23

27

32

36 42 49

58 69

83 10

0 112 118 12

5 133 14

6 160 17

5

-20 40 60 80

100 120 140 160 180 200

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

FY17

FY18

FY19

EFY

20E

FY21

E

(Rs bn)

0.3 0.3

0.3

0.3 0.4 0.4 0.5 0.

5 0.6 0.

7 0.8 1.

0 1.

2 1.

5 1.7 1.

8 2.0 2.

1 2.2 2.

3

0.0

0.5

1.0

1.5

2.0

2.5

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

PFY

13P

FY14

PFY

15P

FY16

PFY

17P

FY18

PFY

19E

FY20

EFY

21E

(Rs/stick)

ITC’s cigarette revenue grew by ~9% CAGR during FY01-18 despite no volume growth ITC’s cigarette volumes are down ~20% from its peak in FY12 owing to ballooning of illegal cigarette ITC’s cigarette EBIT grew by ~14% CAGR during FY01-18 despite steep rise in taxes

ITC: COMPANY UPDATE

Page | 14

Cigarette value growth: Sustained positive growth despite several macro and tax related headwinds

Cigarette volume growth: ITC coming out of difficult phase of volume pressure


Favorable base to drive optical volume growth in cigarette business which would be the key thrust in re-rating the stock

19

14

13

1

-1

2

6

10

6 7

25

7

2

5 6

9

-5.0

0.0

5.0

10.0

15.0

20.0

Mar

-14

Jun-

14Se

p-14

Dec-

14M

ar-1

5Ju

n-15

Sep-

15De

c-15

Mar

-16

Jun-

16Se

p-16

Dec-

16M

ar-1

7Ju

n-17

Sep-

17De

c-17

Mar

-18

Jun-

18

(%)

(2) (3) (4)

(15)(13)

(17)(15)

(4)

1 3 4

(1) (1)

1

(6)(4) (3)

1

-20.0

-15.0

-10.0

-5.0

0.0

5.0

Mar

-14

Jun-

14Se

p-14

Dec-

14M

ar-1

5Ju

n-15

Sep-

15De

c-15

Mar

-16

Jun-

16Se

p-16

Dec-

16M

ar-1

7Ju

n-17

Sep-

17De

c-17

Mar

-18

Jun-

18

(%)

ITC: COMPANY UPDATE

Page | 15

FMCG: Growth is value accretive Strategy to grow profitably: ITC has been focusing on

profitable growth for its FMCG business. The company has done several new launches/re-launches and acquisitions in the packaged food and personal care categories. ITC will acquire those brands which it can leverage with its strong procurement and distribution network. Most of the launches are in the newer formats (shower gel, pocket deo, innovative sanitizers, etc.) where competition is less and ITC can scale brands in such formats. As per our FMCG segment mapping (link), ITC’s addressable market offers a 13x opportunity headroom. In the backdrop of improving consumption dynamics and reducing losses in the emerging categories, management guides for a sustainable mid-single digit EBIT margin from FY21 onwards (our earlier estimate was 3%).

FMCG business is skewed towards packaged food: The company has been successful in building brands particularly in the packaged food portfolio (Aashirvaad, Sunfeast, Bingo, Yippee, etc) which contributes ~75% of the FMCG business. We foresee significant scope for brand extension in Aashirvaad and Sunfeast brand. Besides, Chocolates, Juices and Dairy business have immense potential to attain scale.

Personal care growth is led by innovation: ITC has also developed strong brands in the non packaged food business (Personal care, Apparels, Education & Stationary, Agarbatti) which contributes the remaining 25%. Personal care portfolio growth is driven by several innovative launches. Engage pocket deo (~Rs 60) now contributes more than a third of the deo portfolio, Engage has 11% market share in deo (Fog at 17%). Fiama has become stronger in the shower gel business and has become number 2 player at 18% market share followed by Nivea at 20%.

The shower gel business is ~10% of the soaps business. ITC can play futuristic categories in the non-food portfolio given its appetite to invest behind brands.

FMCG Revenue Mix: Packaged food dominates

Source: Company, HDFC sec Inst Research Top brands in FMCG (size at consumer level)


Entry in new categories (FY19) Brand Product launches pipeline Sunfeast Wonderz Dairy beverages Dermafique Anti-ageing cream na Chocolates (mass segment) na Dairy VAP ITC Masterchef Frozen snacks

FMCG acquisition history Brand Category Target Period

Nimyle Floor cleaner Arpita Agro FY19

Charmis Skin care Colgate FY18 Savlon Antiseptic J&J FY16 Shower to shower Powder J&J FY16

B Natural Juices Balan Natural Food FY15

Mint-O Confectionery Candico FY03

Aashirvaad28%

Sunfeast24%

Bingo14%Yippee

7%

Confectionary

3%

Classmate6%

Lifestyle Retail

4%

Vivel3%

Mangaldeep

3%

Engage3%

Safety Matches

2%Fiama

2% Savlon1%

Shower to Shower

<1%

>40,000>35,000

>20,000

>10,000 >10,000 >5,000 >5,000 > 5,000

Aash

irvaa

d

Sunf

east

Bing

o

YiPP

ee

Clas

smat

e

Vive

l

Man

gald

eep

Cand

yman

Rs mn

ITC: COMPANY UPDATE

Page | 16

FMCG segment mapping: ITC’s addressable market offers a 13x opportunity headroom

Brand Current Presence Possible Extension Brand Position Mkt Position Est. Market

Size (Rs mn)

Est. ITC Revenue at Consumer

level (Rs mn)

Key competitors

Food

Aashirvaad

- Wheat - Ghee - Spices - Instant mixes - Read-to-eat - Milk

- Other traditional milk products - Pickles - Grains (white flour, semolina, gram flour)

Mid No. 1 150,000 42,000 - Pillsbury Atta (General Mills) - Silver Coin (Sanghvi Group) - Mother's Recipe

Sunfeast

- Biscuits - Cookies - Cake - Beverage - Pasta

- Modern milk products - Rusk/Bread - Chocolate - Oats - Breakfast packaged food

Mid to Premium

No.1 in premium biscuit segment

590,000 35,000 - Britannia, Parle, PriyaGold, Anmol

Bingo - Packaged Snacks - Other snacking products Mid No. 1 219,000 20,000 - Lays (Pepsi), Diamond (Prataap

snacks), Haldiram

YiPPee - Noodles - Pasta - Oats Mid No. 2 153,000 10,000 - Maggi (Nestle), Top Ramen (Nissin)

Mint-o, Candyman, GumOn - Confectionery - More variants Mid Top 5 40,800 5,000 B-Naturals - Juices - Health Supplements Mid Emerging 30,000 1,000 - Real (Dabur), Tropicana (Pepsi) Fabelle - Chocolate - Mid to Mass chocolates Super-premium Emerging 80,000 100 - Cadburry (Mondelez), Nestle Personal Care

Fiama - Shower Gel - Soap Bar - Talc

- Shampoo - Shaving Cream - Talc - Face wash

Premium No. 2 20,000 3,600

- Nivea: leader with 20% share (Beiersdorf Global) - Palmolive - Dove

Vivel - Soap Bar -More variants Mid na

200,000 6,000

- Lux, Lifebuoy, Dove, Pears, Hamam (HUL) - Godrej No 1, Cinthol (GCPL) - Santoor (Wipro) - Dettol (RB)

Superia - Soap Bar -More variants Mass na

Engage - Deos - Perfume - Pocket Perfume

- Face Wash - Talc Premium No. 2 40,000 4,400

- Fogg : market leader with 17% (Vini) - Wild Stone - Nivea - Park Avenue - Axe

Essenza Di Wills - Perfume - Face cream - Moisturiser - Deo

Super-premium Emerging 20,000 na - Fogg (Vini) - Skinn (Titan) - Park Avenue (Raymond)

ITC: COMPANY UPDATE

Page | 17

Brand Current Presence Possible Extension Brand Position Mkt Position Est. Market

Size (Rs mn)

Est. ITC Revenue at Consumer

level (Rs mn)

Key competitors

Savlon

- Anti-septic liquid - Soaps - Handwash

- Hand wash - Hand sanitizer - Shaving Cream - Shower Gel - Disinfectant liquid

Mid No. 2 10,000 2,000 - Dettol (RB)

Charmis - Cold cream - Moisturiser Mid na na na - Nivea (Beiersdorf Global) - Pond's (HUL)

Dermafique - Anti-aging - More variants Premium Emerging na na - Olay (P&G) - Lakme (HUL) - Nivea (BG)

Shower to Shower - Talc - Shower Gel - Soap Bar - Talc

Mid na 4,000 240

- Himalaya - Dermi Cool (RB) - Boroplus (Emami) - Nycil (Kraft Heinz)

Home Care

Nimyle Floor Cleaner - Kitchen cleaner - More Variants Mid Emerging 100,000 na

- Lizol (RB) - Domex (HUL) - Mr. Muscle (SC Johnson)

Others

Classmate Paperkraft

- Notebooks - Pen - Pencil - Geometric box - Art instruments

- More variants - Office stationery Premium No. 2 100,000 10,000

- Navneet - Luxor - BILT (Balrampur)

Wills Life Style - Increase product range - Enter into mid-premium Premium na na 7,185 - All leading men’s formal wear brands

Aim Ship Home Lites

Safety Matches - Cigarette and gas stove lighters Mid No. 1 10,000 2,357 - Largely unorganised

ITC: COMPANY UPDATE

Page | 18

Quarterly FMCG Revenue Quarterly FMCG EBIT

Source: Company, HDFC sec Inst Research Source: Company, HDFC sec Inst Research FMCG Revenue: Product launches and acquisitions to fuel growth

FMCG EBIT: Set to benefit from high brand investments along with restructuring retail piece

Source: Company, HDFC sec Inst Research Note: FY18 revenue growth is like-like (adj. for GST)


(6.7)

(3.5)

(1.2)

0.3 0.4 0.7 0.3 1.4

2.7 3.5

5.0

(8.0)

(6.0)

(4.0)

(2.0)

-

2.0

4.0

6.0

FY11

FY12

FY13

FY14

FY15

FY16

FY17

FY18

FY19

E

FY20

E

FY21

E

12 11 1113 12

7 75

10

13

3

6

910

16

10

14

0.0

3.0

6.0

9.0

12.0

15.0

18.0

Jun-

14Se

p-14

Dec-

14M

ar-1

5Ju

n-15

Sep-

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c-15

Mar

-16

Jun-

16Se

p -16

Dec-

16M

ar-1

7Ju

n-17

Sep-

17De

c-17

Mar

-18

Jun-

18

(%)

-0.8-0.5

0.5

1.9

-0.4 -0.4 -0.5

0.8

2.6

-0.2-0.1

-0.8

1.9

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3.0

1.7

-1.5-1.0-0.50.00.51.01.52.02.53.03.5

Mar

-14

Jun-

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p-14

Dec-

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ar-1

5Ju

n-15

Sep-

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c-15

Mar

-16

Jun-

16Se

p-16

Dec-

16M

ar-1

7Ju

n-17

Sep-

17De

c-17

Mar

-18

Jun-

18

(%)

20

24 26

16

11

8 8

11

16 15 16

-

5

10

15

20

25

30

FY11

FY12

FY13

FY14

FY15

FY16

FY17

FY18

FY19

E

FY20

E

FY21

E

ITC: COMPANY UPDATE

Page | 19

Hotels: Pursuing an ‘asset right’ strategy The hotel industry is coming out of a deep lull after

the 2007 peak where ARRs and occupancy rates were at life time highs. Room supply in the last decade has moderated as the industry looked to match demand. In the recent years, F&B segment became increasingly important to the industry in the backdrop of low occupancy rates. As a major blow, F&B was impacted in FY18 owing to the highway ban on liquor. We also observed that EBIT margins have fallen ~41% from the peak of FY08 to ~10% in FY18. While EBITDA margins during the same period declined from 47% to 22% in FY18 (higher rooms with lower occupancy rates/ARR).

With a turn in the business cycle for the industry hereon, we expect ITC’s hotel business to enjoy higher ARRs and occupancy rates leading to expansion in EBITDA margins.

ITC is now looking to adopt an ‘asset right’ strategy with higher share of management contracts (50% revenue mix in the next few years vs. 40% currently). Higher share of management contracts coupled with turn in business cycle should drive expansion in RoCE.

Luxury Hotel Demand-Supply and Occupancy (%) Luxury Hotel ARR and RevPAR - Pan India (In Rs)

Source: Bharat Hotel DRHP, HDFC sec Inst Research Source: Bharat Hotel DRHP, HDFC sec Inst Research

60,4

27

75,5

83

89,5

07

35,4

04

48,3

73

60,8

65

59%

64%

68%

50%

55%

60%

65%

70%

-

20,000

40,000

60,000

80,000

100,000

FY14 FY18E FY22P

Room supply Room demandOccupancy Rate (%)

7,050 7,400

8,200

4,150 4,750

5,550

3,000

4,000

5,000

6,000

7,000

8,000

9,000

FY14 FY18E FY22P

ARR (Rs) RevPAR (Rs)

ITC hotels is India’s second largest hotel chain with >100 hotels at >70 destinations ITC hotels has its presence in Luxury and Mid-market segment Type No. of

Hotels No. of rooms

5 Star Properties 26 >4800

Fortune Hotels 46 >3600

WelcomHeritage 35 >800

Total 107 >9200

ITC is looking for an ‘asset right’ strategy in the hotels business as it is now increasingly looking for management contracts Currently owned hotels contribute 60% of revenues while 40% are from managed contracts. ITC is looking to change this mix to 50:50% in the next few years Room inventory

Company Name No of Hotels

No of Rooms

Indian Hotels 122 14,275

ITC Hotels 107 9,200

Lemon Tree 48 4,870

EIH* 13 2,881

Asian Hotels West 2 931

EIH Associated 8 867

Asian Hotels East 2 558

Asian Hotels North 1 507 Source: Companies, HDFC sec Inst Research

ITC: COMPANY UPDATE

Page | 20

ITC hotels is the most profitable among the largest luxury hotel chains

Hotels Revenue (Rs Mn) EBITDA (Rs Mn) EBITDA Margin (%)

FY16 FY17 FY18 FY16 FY17 FY18 FY16 FY17 FY18 Indian Hotels 40,230 40,206 41,036 5,522 6,096 6,704 13.7% 15.2% 16.3% EIH 16,589 15,268 15,984 3,445 2,611 2,989 20.8% 17.1% 18.7% ITC 13,081 13,293 14,041 3,453 3,453 3,453 26.4% 26.0% 24.6% Lemon Tree 3,680 4,121 4,843 1,012 1,165 1,361 27.5% 28.3% 28.1% AH West 3,192 3,643 3,913 796 1,082 1,220 24.9% 29.7% 31.2% AH North 2,410 2,509 2,744 697 811 835 28.9% 32.3% 30.4% EIH Associated 2,452 2,633 2,635 727 729 674 29.7% 27.7% 25.6% AH East 1,927 1,952 1,896 475 431 386 24.7% 22.1% 20.4% Source: Companies, HDFC sec Inst Research Quarterly Hotels Rev. Gr and EBIT Margin Hotels Rev. Gr. And EBIT margin


10

0

7 6

5

11

2

6

11

12 13

-

5.0

10.0

15.0

20.0

25.0

30.0

-

2

4

6

8

10

12

14

FY11

FY12

FY13

FY14

FY15

FY16

FY17

FY18

FY19

E

FY20

E

FY21

E

Revenue Growth (%) EBIT Margin (%)-RHS

ITC Hotel EBIT and EBITDA margin trend

Source: Company, HDFC sec Inst Research EBIT margins have declined from 41% in FY08 to 10% in FY18 owing to cyclical nature of the industry. On the other hand, EBITDA margins have declined from 47% to only 22% (higher depreciation charge)

0%

20%

40%

60%

FY08

FY

09

FY10

FY

11

FY12

FY

13

FY14

FY

15

FY16

FY

17

FY18

EBIT Margin (%) EBITDA Margin (%)

4.5 4.8

2.5

7.3 6.2 6.1

1.0

10.0

5.6

11.9

(5.0)

-

5.0

10.0

15.0

20.0

-

2.0

4.0

6.0

8.0

10.0

12.0

14.0

Dec-

15

Mar

-16

Jun-

16

Sep-

16

Dec-

16

Mar

-17

Jun-

17

Sep-

17

Dec-

17

Mar

-18

Jun-

18

Revenue Growth (%) EBIT Margin (%)-RHS%

ITC: COMPANY UPDATE

Page | 21

Paper: On the path to recovery ITC’s Paperboard and Paper business contributes 86%

of the segment while rest is led by printed materials. Paper business is also a strategic move for backward integration of the cigarette business. A large portion (~30% of the total gross sales) of this business is being consumed internally.

In recent years, ITC’s paper business was impacted owing to slowdown in end user industries such as FMCG (incl. cigarettes), liquor and pharmaceuticals coupled with cheaper imports. On the brighter side, benign input costs, greater use of in-house pulp vs. imports and richer product mix continued to drive EBIT growth.

As per ITC, outlook for Paperboard industry (48% of industry) is at 7.5% CAGR for next 5 years. Within paperboards (ITC holds leadership position), value-added paperboards is expected to grow at 10.5% CAGR driven by growth in FMCG, Pharma and F&B industries.

We expect with better growth from FMCG and other end user industry, ITC’s paper business can sustain low double digit revenue growth. Operating leverage and higher contribution from the value-added products which would further improve the margin profile of this business.

Quarterly Paper Rev. Gr and EBIT Margin Paper Rev. Gr. And EBIT margin


13 11

6

20

11

6

(1) (1)

13 11 11

15.0 16.0 17.0 18.0 19.0 20.0 21.0 22.0 23.0 24.0 25.0

(5)

-

5

10

15

20

25

FY11

FY12

FY13

FY14

FY15

FY16

FY17

FY18

FY19

E

FY20

E

FY21

E

Revenue Growth (%) EBIT Margins (%)-RHS

Per capita paper consumption

Source: Ballarpur industries, HDFC sec Inst Research

ITC commands superior margins in the industry Particulars (Rs mn) FY18 Net Revenues ITC 37,924 Ballarpur Industries 25,461 International Paper 12,640 Century Textiles 8,190 EBITDA ITC 13,168 Ballarpur Industries 3,258 International Paper 2,214 Century Textiles 1,321 EBITDA Margin (%) ITC 35% Ballarpur Industries 13% International Paper 18% Century Textiles 16% Source: Companies, HDFC sec Inst Research

224 218

158 158

78 56

13 0

50

100

150

200

250

USA

Japa

n EU

Sing

apor

e

Chin

a

Glob

al A

vg.

Indi

a

kg

5

3

(2)

0

(0)

4 3

(2)

(4)(5)

(0)

-

5.0

10.0

15.0

20.0

25.0

(8)

(4)

-

4

8

Dec-

15

Mar

-16

Jun-

16

Sep-

16

Dec-

16

Mar

-17

Jun-

17

Sep-

17

Dec-

17

Mar

-18

Jun-

18

Revenue Growth (%) EBIT Margin (%) - RHS

ITC: COMPANY UPDATE

Page | 22

Agri business: a volatile business Agribusiness is largely a trading business which

consists of unmanufactured tobacco (37% revenue mix) and other agri products and commodities (wheat, soya, spices, coffee etc). Like any other commodity business, agribusiness is prone to high volatility. However, over a period of time ITC has been able to develop strong network with farmers which provides extensive backward linkages to agribusiness and has reduced volatility. ITC’s ‘e-Choupal’ model created a significant two-way multi-

dimensional channel between farmers and ITC. Through ‘e-Choupal’ ITC is now connected with more than 4mn farmers across 40,000 villages.

Strong procurement via its agri business is a key driver in supporting its food business. ITC has scaled its existing products (Aashirvaad) successfully and now looks to enter newer categories (like ghee, dairy beverages, frozen foods etc) which is supported by strong procurement network.

Quarterly Agri business Rev. Gr and EBIT Margin Agri business Rev. Gr. And EBIT margin


27 20

43

2

11

0

(6)

(15)

9 11 11

6.0

8.0

10.0

12.0

14.0

(20)

(10)

-

10

20

30

40

50

FY11

FY12

FY13

FY14

FY15

FY16

FY17

FY18

FY19

E

FY20

E

FY21

E

Revenue Growth (%) EBIT Margin (%)-RHS

Agri business revenue by segment

Source: Company, HDFC sec inst research

16 17 18 17

41 40 35 29

-

20

40

60

FY15

FY16

FY17

FY18

Unmanufactured Tobacco Other agri products and commodities

Rs bn

(7)

27

20

2

13

6

(1)

5

(8)(6)

14

-2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0

(15)(10)

(5)-5

10 15 20 25 30

Dec-

15

Mar

-16

Jun-

16

Sep-

16

Dec-

16

Mar

-17

Jun-

17

Sep-

17

Dec-

17

Mar

-18

Jun-

18

Agri. Revenue Growth (%) EBIT Margin (%) - RHS

ITC: COMPANY UPDATE

Page | 23

Capital Allocation: Prudent Allocation FCF continues to balloon as ITC looks to deploy capex judiciously

Capex Allocation: In recent years, FMCG dominates capital allocation

Source: Company, HDFC sec Inst Research Source: Company, HDFC sec Inst Research Cumulative Capex (Rs bn) FY08-18 (10 Yr) FY14-18 (5 Yr) FY16-18 (3 Yr) Cigarettes 42 19 6 FMCG Others 50 39 27 Hotels 48 25 13 Agri 11 7 4 Paper 50 26 18 Unallocated 12 12 12 Total 212 128 80 Source: Company, HDFC sec Inst Research Focus on incremental RoCE: ITC plans to invest ~Rs

100bn capex over the next 3 years. It will deploy 35% of its incremental capital to the FMCG business while Hotel and Paper would consume 20% each in the

coming years. The intensity of capex in Hotel business would decline after completion of 4 hotels (in 3 years). Therefore, capital allocation in the non-FMCG business would be limited going ahead.

ITC has spent ~Rs 27bn on FMCG in the last 3 years vs. HUL’s ~Rs 31bn, despite ~1/3rd of revenue scale

30 35 44

55 60 71 73

98 99 106

132

0

20

40

60

80

100

120

140

0%

20%

40%

60%

80%

100%

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

FY17

FY18

Capex as % of OCF FCF as % of OCF OCF - RHS

Rs bn

20% 15% 7%

23% 30%34%

23% 20%16%

5% 5%5%

23% 21%23%

6% 9% 15%

0%

20%

40%

60%

80%

100%

FY08-18 (10Yr) FY14-18 (5 Yr) FY16-18 (3Yr)

Cigarettes FMCG OthersHotels AgriPaper Unallocated

ITC: COMPANY UPDATE

Page | 24

ITC’s Recent Performance Quarterly Financials (Standalone) Year to March (Rs mn) 1QFY19 1QFY18 YoY (%) 4QFY18 QoQ (%) FY18 FY17 YoY (%) Gross Revenue 181,717 160,106 13.5 179,335 1.3 670,819 641,742 4.5 Net Revenue* 108,746 99,547 9.2 108,132 0.6 406,275 400,887 1.3 Material Expenses 41,094 38,360 7.1 40,012 2.7 157,900 159,763 (1.2) Employee Expenses 7,430 6,746 10.1 6,113 21.5 24,875 24,443 1.8 Other Operating Expenses 18,201 16,976 7.2 20,568 (11.5) 68,091 70,900 (4.0) EBITDA 42,021 37,464 12.2 41,440 1.4 155,410 145,780 6.6 Depreciation 2,987 2,682 11.4 3,040 (1.7) 11,454 10,380 10.3 EBIT 39,034 34,782 12.2 38,400 1.7 143,956 135,400 6.3 Other Income 4,039 4,768 (15.3) 5,165 (21.8) 21,298 19,859 7.2 Interest Cost 73 104 (29.3) 232 (68.4) 867 230 277.6 PBT before exceptional 42,999 39,446 9.0 43,333 (0.8) 164,388 155,030 6.0 Exceptional - - na - na 4,129 - na PBT 42,999 39,446 9.0 43,333 (0.8) 168,517 155,030 8.7 Tax 14,813 13,841 7.0 14,006 5.8 56,285 53,021 6.2 RPAT 28,187 25,605 10.1 29,327 (3.9) 112,233 102,009 10.0 APAT 28,187 25,605 10.1 29,327 (3.9) 110,853 102,009 8.7 EPS 2.3 2.1 9.6 2.4 (3.9) 9.1 8.4 8.2 % Of Net Revenue 1QFY19 1QFY18 YoY (bps) 4QFY18 QoQ (bps) FY18 FY17 YoY (bps) Material Cost 37.8 38.5 (75) 37.0 79 38.9 39.9 (99) Employee Expenses 6.8 6.8 6 5.7 118 6.1 6.1 3 Other Expenses 16.7 17.1 (32) 19.0 (228) 16.8 17.7 (93) EBITDA 38.6 37.6 101 38.3 32 38.3 36.4 189 Tax Rate 34.4 35.1 (64) 32.3 213 33.4 34.2 (80) APAT 25.9 25.7 20 27.1 (120) 27.3 25.4 184 Source: Company, HDFC sec Inst Research Note: Excise duty reversal we have included in the other expenses

Net revenues grew by 9.2% (exp of 8.2%) Cigarette volumes grew by 1% (exp flat) FMCG business grew by 14% (like-like) driven by packaged foods and personal care products Despite several headwinds, ITC registered healthy 10% APAT growth Exceptional item in FY18 is on account of tax provision written-back (Tamil Nadu entry tax) In spite of two tax hikes (FY18 Budget and GST), the company registered 9% earnings growth during FY18

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Quarterly Segmental (Reported) Year to March (Rs mn) 1QFY19 1QFY18 YoY (%) 4QFY18 QoQ (%) FY18 FY17 YoY (%) Segmental Revenues Cigarettes* 51,276 87,742 (41.6) 49,365 3.9 228,940 340,020 (32.7) FMCG 28,700 26,009 10.3 30,518 (6.0) 113,286 105,118 7.8 Hotels 3,413 3,049 11.9 4,080 (16.4) 14,175 13,417 5.6 Agribusiness 31,513 27,605 14.2 18,083 74.3 80,677 82,646 (2.4) Paperboards, Paper & Packaging 13,558 13,598 (0.3) 13,008 4.2 52,496 53,629 (2.1) Total 128,460 158,003 (18.7) 115,054 11.7 489,574 594,830 (17.7) Less: Inter-segment revenue 21,238 20,781 2.2 7,996 165.6 50,005 44,813 11.6 Total 107,222 137,222 (21.9) 107,058 0.2 439,569 550,017 (20.1) Segmental EBIT Cigarettes* 35,584 32,741 8.7 35,058 1.5 133,408 125,139 6.6 FMCG 501 54 823.0 912 (45.0) 1,641 281 483.6 Hotels 132 53 149.0 755 (82.5) 1,398 1,110 26.0 Agribusiness 1,945 2,351 (17.3) 1,240 56.9 8,486 9,058 (6.3) Paperboards, Paper & Packaging 2,957 2,573 14.9 2,424 22.0 10,422 9,658 7.9 Total 41,119 37,773 8.9 40,388 1.8 155,355 145,246 7.0 Less: (a) Interest Cost & Bank Charges 73 104 (29.3) 232 (68.4) 867 229.5 277.6 (b) Other Un-allocable Expenses (1,954) (1,777) 10.0 (3,177) (38.5) (14,028) -10012.9 40.1 PBT 42,999 39,446 9.0 43,333 (0.8) 168,517 155,030 8.7 Capital Employed Cigarettes 32,113 44,294 (27.5) 33,321 (3.6) 32,113 44,294 (27.5) FMCG 67,115 65,082 3.1 57,167 17.4 67,115 65,082 3.1 Hotels 50,921 48,008 6.1 49,991 1.9 50,921 48,008 6.1 Agribusiness 25,610 27,248 (6.0) 25,072 2.1 25,610 27,248 (6.0) Paperboards, Paper & Packaging 60,970 57,841 5.4 59,527 2.4 60,970 57,841 5.4 Total 236,729 242,473 (2.4) 225,078 5.2 236,729 242,473 (2.4) Unallocated corporate assets 307,725 239,740 28.4 288,923 6.5 307,725 239,740 28.4 Total capital employed 544,455 482,213 12.9 514,001 5.9 544,455 482,213 12.9 Source: Company, HDFC sec Inst Research *Cigarette revenue growth is not comparable

Cigarette business grew by ~9% during the quarter with ~1% volume growth. We were expecting 8% cigarette growth with flat volumes FMCG biz on like-to-like basis grew by 14% (17% adjusting for input tax credit), led by healthy growth in branded packaged foods and personal care Hotel biz grew by 12% driven by improvement in ARR and growth in F&B sales Agri business rebounded with 14% growth after a painful FY18 Paper business was weak (flat growth). With recovery in FMCG volumes we expect paper business to rebound in the near-term

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EBIT Margin (Reported) Year to March (Rs mn) 1QFY19 1QFY18 YoY (bps) 4QFY18 QoQ (bps) FY18 FY17 YoY (bps) Cigarettes* 69.4 37.3 3,208 71.0 (162) 58.3 36.8 2,147 FMCG 1.7 0.2 154 3.0 (124) 1.4 0.3 118 Hotels 3.9 1.7 213 18.5 (1,462) 9.9 8.3 159 Agribusiness 6.2 8.5 (234) 6.9 (68) 10.5 11.0 (44) Paperboards, Paper & Packaging 21.8 18.9 289 18.6 317 19.9 18.0 184 Total 32.0 23.9 810 35.1 (309) 31.7 24.4 731 Source: Company, HDFC sec Inst Research *Cigarette EBIT margin is not comparable

EBIT margin expansion for FMCG business was driven by enhanced scale, product mix enrichment and cost management initiatives notwithstanding higher investments in brand building and gestation costs of new categories Hotels EBIT expansion was driven by higher room rates and operating leverage Paper EBIT expansion was driven by richer mix, higher utilisation and benign input prices

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Assumptions

FY17 FY18 FY19E FY20E FY21E Cig. Revenue Gr (%) 5.1 4.9 8.3 8.2 8.2 Cig. Volume Gr (%) 1.4 (3.0) 4.6 3.0 3.0 Cig. Price Gr (%) 3.7 7.9 3.7 5.2 5.2 FMCG Revenue Gr (%) 8.0 7.8 15.9 15.5 16.3 Hotels Revenue Gr (%) 1.6 5.6 10.6 12.5 12.8 Agri Revenue Gr (%) (5.8) (15.0) 8.7 10.7 10.9 Paper Revenue Gr (%) (0.8) (0.7) 13.3 11.4 11.5 Gross Margin (%) 62.5 63.5 64.0 64.2 64.5 Employee (% of sales) 8.5 8.7 8.6 8.6 8.6 ASP (% of sales) 1.9 2.1 2.2 2.3 2.3 Distribution (% of sales) 2.0 2.1 2.2 2.3 2.4 Other Expenses (% of sales) 14.1 12.8 12.8 12.9 12.9 EBITDA Margin (%) 36.1 37.9 38.2 38.1 38.3 Tax Rate (%) 34.6 34.0 34.0 34.0 34.0 Source: Company, HDFC sec Inst Research Estimate change

FY19E FY20E FY21E

New Old Change (%) New Old Change (%) New Old Change (%) Revenue 477,099 472,762 0.9 528,138 519,974 1.6 586,676 570,187 2.9 EBITDA 182,299 180,006 1.3 201,389 200,078 0.7 224,654 220,675 1.8 APAT 124,565 122,785 1.5 137,819 135,457 1.7 153,880 149,823 2.7 EPS 10.2 10.1 1.5 11.3 11.1 1.7 12.6 12.3 2.7 Source: HDFC sec Inst Research

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Peer Set Comparison

Company MCap

(Rs bn)

CMP (Rs) Reco. TP

(Rs)

EPS (Rs) P/E (x) EV/EBITDA (x) Core RoCE (%)

FY19E FY20E FY21E FY19E FY20E FY21E FY19E FY20E FY21E FY19E FY20E FY21E

HUL 3,493 1,666 NEU 1,709 29.4 35.5 42.7 54.9 45.5 37.9 38.2 32.1 27.0 71.4 73.8 74.4 ITC 3,709 303 BUY 382 10.2 11.3 12.6 29.6 26.7 24.0 18.8 16.8 14.9 37.6 38.1 40.3 GCPL 905 1,329 NR 1,160 26.7 31.3 37.3 49.7 42.5 35.6 37.3 31.7 26.7 20.5 23.2 27.3 Britannia 728 6,060 NEU 6,257 105.5 130.6 158.9 57.4 46.4 38.1 38.7 31.3 26.0 46.3 50.4 54.7 Dabur 816 463 BUY 498 9.8 12.2 14.4 47.0 38.1 32.1 39.6 32.4 27.0 53.6 60.7 68.3 Marico 444 344 BUY 388 8.2 10.6 12.4 42.0 32.4 27.8 30.3 23.9 20.6 46.2 56.7 62.5 Colgate 305 1,121 NEU 1,185 28.7 32.8 37.8 39.0 34.2 29.7 23.9 20.4 17.6 69.6 81.9 96.1 Emami 249 545 BUY 648 14.3 17.2 20.5 38.0 31.7 26.6 27.7 23.4 19.7 29.0 37.7 48.4 Jub. Food 183 1,386 BUY 1,562 25.8 31.8 39.2 53.7 43.6 35.3 28.6 23.7 19.8 56.6 71.9 89.2 Source: HDFC sec Inst Research

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Income Statement (Rs mn) FY17 FY18 FY19E FY20E FY21E Net Revenues 428,036 434,489 477,099 528,138 586,676 Growth (%) 9.2 1.5 9.8 10.7 11.1 Material Expenses 160,492 158,555 171,755 189,073 208,270 Employee Expense 36,317 37,609 40,973 45,420 50,401 ASP Expense 8,107 9,041 10,496 12,147 13,494 Distribution Expense 8,560 9,041 10,496 12,147 14,080 Other Expenses 60,201 55,414 61,079 67,962 75,778 EBITDA 154,359 164,830 182,299 201,389 224,654 EBITDA Growth (%) 6.8 6.8 10.6 10.5 11.6 EBITDA Margin 36.1 37.9 38.2 38.1 38.3 Depreciation 11,528 12,363 13,256 14,678 16,356 EBIT 142,831 152,467 169,043 186,711 208,298 Other Income (Inc. EO) 17,615 18,319 20,366 22,808 25,587 Interest 243 899 805 855 909 PBT 160,204 174,016 188,603 208,664 232,976 Total Tax 55,491 59,164 64,125 70,946 79,212 RPAT 104,772 114,927 124,565 137,819 153,880 Exceptional Gain/(loss) - 2,725 - - - Adjusted PAT 104,772 112,202 124,565 137,819 153,880 APAT Growth (%) 10.3 7.1 11.0 10.6 11.7 Adjusted EPS (Rs) 8.6 9.2 10.2 11.3 12.6 EPS Growth (%) 9.6 6.6 11.0 10.6 11.7


Balance Sheet (Rs mn) FY17 FY18 FY19E FY20E FY21E SOURCES OF FUNDS Share Capital - Equity 12,147 12,204 12,204 12,204 12,204 Reserves 451,982 512,897 561,815 615,651 676,612 Total Shareholders' Funds 464,129 525,101 574,019 627,855 688,816 Minority Interest 2,947 3,345 3,258 3,157 3,042 Long Term Debt 184 115 115 115 115 Short Term Debt 191 174 191 210 231 Total Debt 375 289 306 325 346 Net Deferred Taxes 18,333 18,749 19,000 19,271 19,564 Other non current liabilities 2,174 2,596 2,596 2,596 2,596 TOTAL SOURCES OF FUNDS 487,959 550,080 599,179 653,205 714,365 APPLICATION OF FUNDS Net Block 157,778 163,907 183,950 208,872 233,017 CWIP 49,180 77,353 78,353 67,153 58,194 Goodwill 2,314 2,314 2,314 2,314 2,314 LT Loans & Advances 20,849 21,014 22,895 24,952 27,200 Total Non-current Assets 230,120 264,587 287,512 303,291 320,724 Inventories 81,161 74,951 79,646 85,857 92,608 Debtors 24,743 26,823 28,626 31,160 34,614 Other Expenses 17,471 26,523 27,849 29,241 30,704 Cash & Equivalents 205,488 249,525 262,826 299,566 341,260 Total Current Assets 328,863 377,821 398,948 445,824 499,185 Creditors 26,593 34,962 33,132 36,676 40,741 Other Current Liabilities & Provns 44,430 57,367 54,149 59,234 64,803 Total Current Liabilities 71,023 92,328 87,281 95,911 105,544 Net Current Assets 257,839 285,493 311,666 349,914 393,641 TOTAL APPLICATION OF FUNDS 487,960 550,080 599,179 653,205 714,365


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Cash Flow Statement (Rs mn) FY17 FY18 FY19E FY20E FY21E Reported PBT 160,263 174,091 188,603 208,664 232,976 Non-operating & EO Items (2,257) (3,379) - - - Interest Expenses (8,789) (8,748) (9,614) (10,398) (11,244) Depreciation 11,528 12,363 13,256 14,678 16,356 Working Capital Change 444 17,364 (14,754) (3,564) (4,281) Tax Paid (54,916) (59,996) (63,874) (70,675) (78,919) OPERATING CASH FLOW ( a ) 106,273 131,694 113,617 138,706 154,888 Capex (30,715) (27,985) (34,299) (28,401) (31,541) Free Cash Flow (FCF) 75,558 103,709 79,318 110,305 123,347 Investments (10,749) (50,814) (15,000) (15,000) (15,000) Non-operating Income 8,955 7,660 10,419 11,253 12,153 INVESTING CASH FLOW ( b ) (32,509) (71,139) (38,880) (32,148) (34,388) Debt Issuance/(Repaid) (132) 24 17 19 21 Interest Expenses (255) (486) (805) (855) (909) FCFE 75,171 103,247 78,530 109,470 122,459 Share Capital Issuance 10,670 9,128 (0) (0) (0) Dividend (83,330) (70,884) (75,647) (83,983) (92,918) Others 37 8 - - - FINANCING CASH FLOW ( c ) (73,010) (62,211) (76,435) (84,818) (93,806) NET CASH FLOW (a+b+c) 754 (1,656) (1,698) 21,740 26,694 EO Items, Others 33,403 (978) - - - Closing Cash & Equivalents 29,674 28,996 27,298 49,037 75,731


Key Ratios FY17 FY18 FY19E FY20E FY21E PROFITABILITY (%) GPM 62.5 63.5 64.0 64.2 64.5 EBITDA Margin 36.1 37.9 38.2 38.1 38.3 EBIT Margin 33.4 35.1 35.4 35.4 35.5 APAT Margin 24.5 25.8 26.1 26.1 26.2 RoE 23.5 22.7 22.7 22.9 23.4 RoIC (or Core RoCE) 36.4 37.2 37.6 38.1 40.3 RoCE 23.4 22.6 22.6 22.9 23.3 EFFICIENCY Tax Rate (%) 34.6 34.0 34.0 34.0 34.0 Fixed Asset Turnover (x) 0.6 0.6 0.7 0.7 0.7 Inventory (days) 69.2 63.0 60.9 59.3 57.6 Debtors (days) 21.1 22.5 21.9 21.5 21.5 Other Current Assets (days) 14.9 22.3 21.3 20.2 19.1 Payables (days) 22.7 29.4 25.3 25.3 25.3 Other Current Liab & Provns (days) 37.9 48.2 41.4 40.9 40.3 Cash Conversion Cycle (days) 44.6 30.2 37.4 34.8 32.6 Net D/E (x) (0.4) (0.5) (0.5) (0.5) (0.5) Interest Coverage (x) 587.8 169.6 209.9 218.5 229.2 PER SHARE DATA (Rs) EPS 8.6 9.2 10.2 11.3 12.6 CEPS 9.6 10.2 11.3 12.5 13.9 Dividend 4.7 5.2 5.7 6.3 7.1 Book Value 38.2 43.0 47.0 51.4 56.4 VALUATION P/E (x) 35.0 32.8 29.6 26.7 24.0 P/BV (x) 7.9 7.0 6.4 5.9 5.4 EV/EBITDA (x) 22.4 20.8 18.8 16.8 14.9 EV/Revenues (x) 8.1 7.9 7.2 6.4 5.7 OCF/EV (%) 3.1 3.8 3.3 4.1 4.6 FCF/EV (%) 2.2 3.0 2.3 3.3 3.7 FCFE/Mkt Cap (%) 2.0 2.8 2.1 3.0 3.3 Dividend Yield (%) 1.6 1.7 1.9 2.1 2.3


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RECOMMENDATION HISTORY

Rating Definitions BUY : Where the stock is expected to deliver more than 10% returns over the next 12 month period NEUTRAL : Where the stock is expected to deliver (-)10% to 10% returns over the next 12 month period SELL : Where the stock is expected to deliver less than (-)10% returns over the next 12 month period

Date CMP Reco Target 10-Oct-17 268 BUY 354 30-Oct-17 269 BUY 358 13-Nov-17 266 BUY 354 27-Dec-17 264 BUY 358 9-Jan-18 266 BUY 358

12-Jan-18 269 BUY 358 20-Jan-18 275 BUY 358 28-Feb-18 266 BUY 358 11-Apr-18 267 BUY 363 17-May-18 286 BUY 358

9-Jul-18 272 BUY 367 27-Jul-18 287 BUY 367 19-Sep-18 303 BUY 382

200

220

240

260

280

300

320

340

360

380

400

Sep-

17

Oct

-17

Nov-

17

Dec-

17

Jan-

18

Feb-

18

Mar

-18

Apr-

18

May

-18

Jun-

18

Jul-1

8

Aug-

18

Sep-

18

ITC TP

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Disclosure: We, Naveen Trivedi, MBA & Siddhant Chhabria, PGDBM, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our views about the subject issuer(s) or securities. HSL has no material adverse disciplinary history as on the date of publication of this report. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Research Analyst or his/her relative or HDFC Securities Ltd. does not have any financial interest in the subject company. Also Research Analyst or his relative or HDFC Securities Ltd. or its Associate may have beneficial ownership of 1% or more in the subject company at the end of the month immediately preceding the date of publication of the Research Report. 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