>ITC: Positive Earnings Cues (AMBIT CAPITAL)

ITC has been a significant outperformer over last three months (absolute 17% and relative 18%). Our review of its balance sheet and earnings expectation suggest that there continues to be an upward bias to earnings growth (18% for FY10-12E) despite some weakness seen in 1QFY11 for cigarette business. We believe the stock can still deliver positive relative outperformance and we
retain our BUY rating on the stock with a March 2011 target price of Rs320.

■ Cigarette business still on solid footing – We believe the recent weakness seen in cigarette volumes is somewhat short term in nature and we expect the company should be able to deliver low positive volume growth in FY11. Over last 12 months it has strengthened its brand portfolio significantly with brands such as Flake Excel and Duke Filter, entered less than 60mm category and augmented its production capacity by more than 20% with the set up of a more than 20 billion capacity stick plant at Ranjangaon near Pune.

■ FMCG business to maintain positive trend – The significant improvement seen in profitability for FY10 (nearly 640bps improvement in EBIT margin) should continue as outlook for both packaged foods and personal product business remains positive. Over last 12 months in case of personal products the company has added significant capacity at its Haridwar plant and also
commissioned new facilities at Manpura, Himachal Pradesh. The nearly threefold increase in capacity implies that the company will be targeting low double-digit volume shares in personal product categories such as Soaps, Shampoo and Skin Cream over next three years. We believe existing players such as Hindustan Unilever, P&G, Dabur and Godrej Consumer will have to
respond suitably to this increased competitive ante from the company.

■ Significant improvement in return ratios – On account of significantly improved working capital management (down nearly 5 days to 34 days in FY10), return on capital for FY10 is nearly 300bps higher v/s our previous expectation of 39%. Considering there is significant headroom for capacity utilization to improve we expect this upward trend in ROCE to continue and touch nearly 56% by FY12.

■ Outlook and Valuation – We expect the company to report 17% growth in topline and 22% in EBIT led by 30% growth in topline and 55% growth in EBIT for non-cigarette business in 1QFY11. Considering positive outlook for its non-cigarette business, improved subsidiary business performance (Surya Nepal and ITC Infotech) and improvement in return ratios, we expect valuations will continue to see improvement. Our target price implies forward P/E multiple of 21x and EV/EBIDTA multiple of 13x and is also consistent with our sum-of-the-parts approach.

To read the full report: ITC