| Summary of Contents
| STOCK UPDATE ITC
Cluster: Apple Green
Recommendation: Buy
Price target: Rs250
Current market price: Rs221 Price target revised to Rs250
Key points
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Excise duty increased by ~15%: The Government of India has imposed a 10% ad valorem duty on 50% of the minimum retail price (MRP) of cigarettes (exceeding the length of 65mm) in the Union Budget 2012-13. This is an additional charge on the existing specified excise duty on different slabs of cigarettes (of above 65mm in length). The move has resulted in an excise duty hike of around 15% for ITC (ahead of our expectation of 8-12% but in line with the Street's expectation of a 15% hike). -
Price increase of 7-9% needed to neutralise the impact: We believe ITC needs to take an additional price increase in the range of 7-9% in its cigarette portfolio (around 2% price hike already implemented prior to the Union Budget 2013) to mitigate the impact of the excise duty hike. A price increase of around 10% in the cigarette portfolio would help the margins to sustain at the current level. -
\Volume growth expectation for FY2013 downgraded: A price increase of additional 7-9% in the cigarette portfolio will have an impact on the sales volume of ITC's cigarette business, resulting in flattish sales for a quarter or two. However, once the prices are absorbed in the market, we expect the volume growth to improve in the subsequent quarters. Hence, we have reduced our cigarette business' volume growth expectation for FY2013 to 3.5% from 6% earlier. -
Marginal downward revision in earnings estimates for FY2013: The downward revision in the sales volume growth estimate of the cigarette business (which contributes around 60% to the overall revenues) has resulted in a downward revision of about 2% in our earnings estimate for FY2013. We have also introduced our FY2014 earnings estimate in this note. -
Likely launch of cigarette in below 65mm category: The government has introduced a new slab of cigarettes of up to 65mm (with excise duty of Rs509 per 1,000 cigarettes) in the Union Budget 2012-13. There is a possibility of the company launching new cigarettes below the 65mm length (priced at around Rs2 per cigarette) under some of its existing brands, which will help it in offsetting the impact of the excise duty hike in the other slabs of cigarettes. Also, the government has increased the excise duty on both hand-made and machine-made bidis by Rs2 per thousand, which will make bidis costlier in the market. Thus, we might see the lower strata of population upgrading themselves from bidis to lower-priced filter cigarettes. -
Valuation and outlook: In view of the strong pricing power and price inelastic nature of the category, we expect ITC to hike the prices in the portfolio in the coming quarters to safeguard its margins. Nevertheless, any significant hike in the value-added tax (VAT) rate in the key states would be risk to the margins of ITC's cigarette business. Though we expect the cigarette business to record a sales volume growth of around 3.5% in FY2013 but we expect it to improve to 6-7% in FY2014 (unless there is no substantial increase in the Union Budget 2013-14). Overall, we expect the top line and bottom line to grow at compounded annual growth rates (CAGRs) of 16% and 19% respectively over FY2011-14.
We have rolled over our price target to the FY2014 earnings estimate. Hence our revised price target stands at Rs250 (based on 23x its FY2014E earnings per share [EPS] of Rs10.9). In view of the strong balance sheet, better earnings visibility and about 15% upside from the current level, we maintain our penchant for ITC in the large-cap FMCG space. At the current market price the stock trades at 24.0x its FY2013E EPS of Rs9.2. We maintain our Buy recommendation on the stock.
SECTOR UPDATE Pharmaceuticals Budget 2013 is net negative for pharma players Key points -
Negatives outweighs positives in Union Budget 2013 for pharma: The proposal of the Union Budget 2013 to increase the basic excise duty and extend the applicability of alternate minimum tax (AMT) to units controlled by partnerships under certain conditions are some of the key provisions which would materially impact the performance of a few players in the pharmaceutical (pharma) sector. The provisions related to weighted deduction of 200% for in-house research and development (R&D) expenditure have been extended for another five years. A higher allocation of funds for building infrastructure in rural areas and concession in customs duty on import of medical devices including raw materials for medical devices are some of the key bounty for the sector. The net impact we feel remains negative for key players in the short to medium term. -
Sun Pharma and Cadila Healthcare to take steeper impact among peers: These proposals are set to increase the tax burden for companies like Sun Pharmaceutical Industries (Sun Pharma; 59% contribution of profits from partnership-based undertakings), Cadila Healthcare (58% of profits being contributed by partnered undertakings) and Torrent Pharmaceuticals (Torrent Pharma; undisclosed profit from partnership based undertakings), as they have manufacturing units in Sikkim which are being controlled by partnership firms floated to by-pass taxation meant for only companies. -
We revise earnings estimates, target price: We revise our earnings estimates for Sun Pharma, Cadila Healthcare and Torrent Pharma to factor the new provisions proposed in the budget, which would lead to an incurrence of a higher effective tax rate for the mentioned companies. Accordingly, we have revised downwards our earnings estimate for Sun Pharma by 10% and 9% for FY2013 and FY2014 respectively while Cadila Healthcare's earnings estimates have been reduced by 5% and 6% for FY2013 and FY2014 respectively. Torrent Pharma, which started its partnership based manufacturing units in FY2011 is likely to have a marginal impact of 2-3% in FY2013 and FY2014 assuming a 25% contribution to consolidated profits from its partnership firm based in Sikkim. We have reduced our target price proportionately for these companies. | | Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a postition in the companies mentioned in the article. | |
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