Cigarettes lose their cool; FMCG division tries hard but can’t fire ITC’s Q1

ITC Ltd’s mainstay cigarette business was in disarray during the April-June quarter due to the lockdown, which disrupted an estimated 45 days.

Cigarette volumes turned out to be a shade worse than some analysts’ expectations, and are estimated to have dropped by 35-40% in Q1. Earnings before interest and tax (Ebit) of the cigarettes division fell 39% year-on-year (y-o-y), with profit margins falling to a multi-quarter low of 61.1%. In the year-ago period, margins were around 71%.

Meanwhile, revenue of ITC’s fast-moving consumer goods (FMCG) business amounted to as much as 88% of the cigarettes business in Q1, thanks to the big drop in revenues of the latter. A year ago, the division’s revenue was only about three-fifths the size of the cigarettes business.

What’s more, profits of the division rose sharply. But profit margins in this segment are minuscule, as ITC keeps adding new product categories and spends considerable amounts in brand building and business development. Ebit margins of the division stood at a measly 3.7% last quarter. As such, the impressive growth in the division didn’t really move the needle for ITC. ITC’s earnings before interest, tax, depreciation and amortization (Ebitda) declined as much as 42% y-o-y, in line with the fall in profit of the cigarettes business. The FMCG business performed relatively better, thanks to the rise in at-home food consumption due to the lockdown. ITC said growth in the FMCG business stood at 18.8%, excluding the education and stationery products business.

Additionally, sales of staples, convenience foods, and health and hygiene products rose by 34%. On the other hand, discretionary categories, and those with higher ‘out-of-home’ consumption, declined by 25%.

Meanwhile, ITC’s hotels business posted an Ebit loss for the quarter, as operations came to a standstill owing to travel restrictions. The loss in the business was roughly double the profit made by the FMCG division.

The paper business’ Ebit halved owing to lower offtake from end-user industries and subdued domestic demand. The agri business did a notch better.

Going ahead, the hotels business should continue to be a drag as the pandemic will limit demand. While the cigarette business definitely needs to fire more, it would help if the momentum in FMCG sustains.While FMCG contributed only 2.4% to ITC’s Ebit in FY20, it is crucial from the valuation point of view, given that consumer businesses generally fetch higher valuations. In the sum-of-the-parts break-up of ITC’s value, FMCG’s share stands at 19.5% in Jefferies India Pvt. Ltd’s estimates, whereas cigarettes account for 62.5%.

“The FMCG business has the potential to drive medium-term stock re-rating, if the business trajectory continues to show as much promise in times to come,” said analysts from JM Financial Institutional Securities Ltd in a note on 24 July.