The historically unparalleled, leading FMCG company, ITC LTD, managed to live up to its expectations yet again, with a steady 10% YOY increase in standalone net profit for the quarter ended June 2018. Not only did the Net Sales and EBITDA augment, it was supported by a much-needed rise in cigarette volumes as well.
THE MOST IMPORTANT QUESTION FOR EVERY INVESTOR
The aspiration to create an enduring value for the nation is manifest in ITC’s traditional and greenfield businesses encompassing Fast Moving Consumer Goods (FMCG), Hotels, Paperboards & Specialty Papers, Packaging, Agri-Business, and Information Technology.This is not only easier said, but the profound repute that the company enjoys around its brands, it seems it was easier done as well.
But wait, something’s been unusual lately. The year gone by has witnessed ITC’s revenue plunge in a manner that has left analysts stunned, or it could pretty much be said, left the investors asking questions about the company’s “steady” business or its “secure” future. So, what exactly happened in this phase? How did things turn around so fast and yet so strong? And the most important question – Is the company still worthy of being the stock every investor holds in his portfolio with conviction? Before drawing conclusions, let’s find out.
THE GST IMPACT
It all started with the much criticized and debated introduction of the landmark reform, Goods and Services Tax (GST) implemented from July 1,2017. With the setting in of the tax reform, its acceptance seemed quite ambivalent, but for a company like ITC, which majorly earns its revenue through a product that is not really encouraged (cigarettes), it was a clear resentment and a big red flag because the consequences were apparent.
But surprisingly, with the announcement of the tax rates as the reform was ready to set in, ITC’s share price saw a near 10% jump from end June levels. Well, it turned out that all this occurred as a result of an anomaly. The weighted average value added tax (VAT) rate on cigarettes was 28.7% and in line with that, GST was kept at 28%. In addition, compensation cess was to be levied at 1.05 times the specific rate, or 5% extra, the specific excuse duty rates.
“However, this method of calibrating the compensation cess did not take into consideration cascading of taxes (that is, in earlier regime, VAT being charged on value inclusive of the excise duty). As a result, the total tax incidence on cigarettes in GST regime has come down, as compared to the total tax in pre-GST regime,” the finance ministry said in a statement. “While any reduction in tax incidence on items of mass consumption would be welcome, the same would be unacceptable in case of demerit goods like cigarettes.”
The GST Council met on 17th July,2017 and made amends to correct the anomaly. The tax rate of 28% and ad valorem cess of 5% remained the same except in the case of other items falling in the cigarette category. “The increase in compensation cess on cigarettes as announced by the GST Council ranges from Rs. 485 to Rs. 792 per thousand cigarettes. Under the ‘others’ segment i.e. cigarettes of length exceeding 75 mm (including the length of filter), a 31% increase in the ad valorem component of the cess has been levied,” said ITC. So total on that is 36%. “The cumulative growth in tax incidence on cigarettes, after cognizing for the latest increase in cess rates, stands at a staggering 202% since 2011-12, i.e. the last six years,” it added.
However, ITC, which have brands that includes Wills Navy Cut, Gold Flake, Insignia, India Kings and Classic said that despite the extremely challenging operating environment, it sustained its leadership position in the industry through focus on delivering world-class products, continuous innovation and value addition. In the first quarter of 2017-18, ITC’s revenue from cigarettes increased 6.60% to Rs. 8,774.16 crore, from Rs. 8,230.60 crore in the year-ago period.
Undoubtedly, the biggest source of revenue for the company stands from its FMCG business, which it is renowned for. Among the FMCG products, cigarette (brands include Insignia, India Kings, Classic, Gold Flake, American Club, Navy Cut, Players, Scissors, Capstan, Berkeley, Bristol, Flake, Silk Cut, Duke & Royal) has turned out to be ITC’s foremost contributor at about 62% (34,002 crores) of total sales in the FY 16-17. However, the concern lies here because this has come down drastically at 51% (22,894 crores) in the past one year at the end of FY 17-18 since the introduction of GST, which the company was actually quite apprehensive of.
Its branded packaged food products have seen a recent increase in sales YOY from 15% to nearly 20%.Needless to say, brands like Bingo, Sunfeast, Aashirvaad and B-Natural are the go to product brands of all households today which gives us an explicit ground to focus on the vision of the company and in its belief to achieve it; not to mention the conservative figure of 232 million Indian adults who consume tobacco daily, the segment which can well be called ITC’s forte. Other prominent brands are Vivel, Engage, Fiama, Mangaldeep (agarbattis) and Aim(matchboxes) that form a part of this paramount FMCG business. All these taken together, the FMCG business contributes a whopping 80% (34,208 crores as on year ended 31st March,2018) of the ITC’s total gross revenue. The second highest contributor in terms of its revenue is the agri-business at 10% followed closely by paperboards at 7-8% and finally hotels at 3%.
HOW THE MASTER PLAYED ITS A-GAME TO PROFITABILITY
The company’s export revenue shows a paltry figure constituting close to 7.5% of the gross sales. However, this is not the path of concern. ITC’s non-FMCG business, its key focus area, grew 4.3% during the first quarter of the current year on a relatively firm base while operating profits at Rs 127.76 crore grew 86% on the back of “enhanced scale, product-mix enrichment and cost management initiatives, despite sustained investment in brand building and gestation costs of new categories“, ITC said in a release.
Paper and packaging segment profit was up 5% from Rs 257 crore to Rs 269 crore, driven by strategic investments in imported pulp substitution, process innovation leading to improved pulp yield, benefits of a cost-competitive fibre chain, product-mix enrichment and higher realization, the company said. As for the hotel business, higher room rates, strong food and beverage sales and high operating leverage boosted the hotels’ segment performance. While revenue from hotels went up from Rs 305 crore to Rs 341 crore, operating profits jumped from Rs 5.31 crore to Rs 13.22 crore.
Severe cost management initiatives helped the conglomerate diversify and thereby beat the dip in its key revenue earning business, especially cigarettes. All businesses except agri-business have seen margin expansions.Despite 1.5% volume growth in cigarettes, against street expectation of a dip of around 1-2% on year, cigarettes sales during the quarter ended June 2018 declined 41.5% in value to Rs 5,127.59 crore as compared to Rs 8,774.16 crore in the corresponding period last fiscal. This drop chiefly contributed in bringing down company’s total revenues to Rs 10,874.59 crore from Rs 13,800.42 crore a year ago. However, profits went up 10% to Rs 2,818.68 crore from Rs 2,560.50 crore in the year-ago period, helped by 32.46% drop in expenses and higher profits from fast-moving consumer goods (FMCG), hotels and paper businesses.
WHAT ANALYSTS SAY?
ITC’s share price hadn’t seen 300 levels since GST set in, until now, after their Q1 results manifested its mettle among its shareholders yet again and validated that mere adversities are assuredly not sufficient to keep the firmly rooted company unabated. The recent price is hovering around 300, and analysts see this mark not only as a historical support, but also as one having a psychological significance for the investors.
“GST definitely created hiccups, but the good thing is that it is all behind us and we are much more stable today. The company did see a muted growth on the back of certain events in the past, but it is now looking at relentless upward growth. We have forayed in 4 new categories on the FMCG front, launching about 30 new products, and expect to do the same next year. The frozen snacks business is one of them, which is already operative on the B2B side, while B2C is yet to roll out. We also expect to launch dairy beverage products in Q2 and penetrate into the competitive and popular skincare segment through our acquired brand Charmis,” said Sanjiv Puri, CEO, ITC Ltd.