>ITC (MERRILL LYNCH)

Overhang of state budgets is behind us

■ Reiterate as Top pick; Raising PO to Rs275
We have increased our estimates for ITC by 2-5% over FY10-12E to factor in improved profitability in agri business and cig price hikes running marginally ahead of our estimates. Our new EPS is Rs10.5 for FY10E and Rs12.5 for FY11E implying a growth of 21.5% in FY10E and 19% in FY11E. We have increased our multiple for ITC to 22xFY11E (20xFY11E) to peg it at a 10% premium to last 5-yr average to reflect improved earnings growth potential. This on an EPS of Rs12.5 for FY11E gives us our PO of Rs275, implying 13% upside potential from current levels.

■ Threat of VAT hike on cig recedes post Andhra budget
With State Budgets over for FY10, the overhang of potential VAT increases in behind us. Post last two year’s declining trend, we forecast cig vol. gr to rebound to 7.5% in FY10. Post the budgets ITC has greater flexibility to balance volume & price growth. Excise savings outweigh the VAT increases in Delhi, Maharashtra and Rajasthan. Overall, we expect cig EBIT gr to accelerate to 18% in FY10. We are not overly worried about increased marketing spends to counter new competition from GPI given strong vol rebound and upside to retail price hikes.

■ FMCG and Agri should do well with improved profitability
We are encouraged to see a decline in FMCG losses in June Q. We believe losses have now peaked despite plans for new category launch in 2H. In agri we expect trend of falling topline but growing EBIT to continue. ITC is shifting its focus on smaller but more profitable commodity basket. Also, rise in tobacco leaf prices is helping ITC as global supply of leaf tobacco remains constrained.

■ Hotels and Paper to bounce back
We expect hotels to improve in 2H in line with economic recovery and on set of tourist season. Notwithstanding papers disappointing in June Q, we expect strong full year performance led by strong topline gr & margin expansion due to mix gain.

To see full report: ITC