12 March 2012
Update | Sector: Consumer
ITC
BSE SENSEX
S&P CNX
17,588
5,360
CMP: INR207
TP: INR230
Buy
Cigarette profits shrug off excise duty increase
Best pre-budget return in the stock since 2006
Bloomberg
Equity Shares (m)
52-Week Range (INR)
1,6,12 Rel. Perf. (%)
M.Cap. (INR b)
M.Cap. (USD b)
ITC IN
7,738.1
216/164
3/-1/25
1,601.8
32.1
Cigarette EBIT CAGR 15% since 2000 despite excise CAGR of 5.8% (excluding FY09).
Non-cigarette EBIT to post 20% CAGR over FY12-14; Outlook positive.
Strong cash flows and improving payout ratio positive; Maintain Buy.
Valuation summary
Y/E March
2011 2012E 2013E
Sales (INR b)
211.7 250.1 289.2
EBITDA (INR b) 74.7 89.7 105.1
NP (INR b)
EPS (INR)
EPS Gr. (%)
BV/Share (INR)
P/E (x)
P/BV (x)
EV/EBITDA (x)
EV/Sales (x)
RoE (%)
RoCE (%)
49.9
6.4
27.3
20.6
32.1
10.0
20.4
7.2
33.2
42.9
60.8
7.9
22.0
24.3
26.3
8.5
17.0
6.1
35.0
45.1
71.3
9.2
17.2
28.7
22.5
7.2
14.2
5.2
34.7
45.6
ITC's stock has appreciated by 4.2% over the past two months, and is the best
pre-budget returns since 2006. This performance is being partly driven by the
strong stock market rally since end December 2011. There are expectations of a
double digit increase in excise duty on cigarettes given the fiscal constraints of
the Central government. However, ITC has given negative returns (after budget)
only on two occasions in the past eight years; as the company has managed to
pass on the increased duties given the superior pricing power. We believe that
any correction in the stock price will provide a good entry point. Maintain
Buy.
Expect double-digit hike in excise duty; VAT to increase in a few states:
There is
high probability of double-digit hike to combat the inflation impact. However,
very sharp excise increase looks unlikely as revenues suffer due to decline in
volumes. Out of the 6 six states that have announced budgets, only Bihar and
J&K hiked the VAT. There seems little incentive to increase VAT beyond 20% as
differential taxes promote cigarette smuggling from neighboring states.
However we expect another 100-150bp increase in the VAT rate (currently 18.5%).
ITC's price increases are ahead of hikes in duty and taxes:
Increases in excise
duty has a cascading impact on taxes as VAT is imposed at post-excise cigarette
rates. We estimate that ITC needs to increase cigarette prices by 2.3% for every
5% increase in excise duty to maintain realizations/stick. The price increase
required to neutralize the impact of a 1% VAT rate increase is ~0.8%. ITC has
been hiking prices at a rate higher than the increase in duties and taxes. We
note that excise duty declined from 55% of sales in FY06 to 44.5% in FY12.
ITC's cigarette segment's EBIT grew 15% even during bad times:
ITC's cigarette
segment posted 16.8% EBIT growth in FY11 and is expected to register ~20%
growth in FY12. The company has been calibrating its price hikes and volume
growth to grow its cigarette EBIT by 15% CAGR since 2003 due to its strong pricing
power. It increased prices by ~6% in FY12 so far. We estimate the cigarette
business to register 15.2% EBIT CAGR post FY12. A lower-than-expected hike in
excise duty and higher volume growth could result in higher growth.
Non-cigarette segments' EBIT up 26% in 9MFY12; outlook positive:
We expect
non-cigarette EBIT to grow at 20% over FY12-14 led by (1) gradual reduction in
the FMCG losses, (2) 14% EBIT CAGR in paperboard led by capacity expansion,
(3) recovery in hotels, and (4) 15% EBIT CAGR in Agri business led by gains from
new leaf tobacco facility in Mysore. We estimate 17% PAT CAGR over FY12-14.
The stock trades at 22.5x FY13E EPS of INR9.2 and 19.2x FY14E EPS of INR10.8.
Buy.
Shareholding pattern % (Dec-11)
Domestic
Inst., 34.8
Foreign
48.1
Others,
17.1
Stock performance (1 year)
ITC
230
205
180
155
130
Sens ex - Reba s ed
Amnish Aggarwal
(AmnishAggarwal@MotilalOswal.com) + 91 22 3982 5404

ITC
Expect double-digit hike in excise duty on cigarettes in FY12-13 budget
The cigarette industry is anticipating a hike in the excise duty on cigarettes in the FY13
budget. It should be noted that the government left the excise duty on cigarettes
unchanged in last year's budget. There is also a high probability that the hike would
be in double digits to combat the inflation impact (as the duty on cigarettes is specific,
it does not capture the inflation impact). We note the long-term excise duty has
increased at a CAGR of 5.8% (excluding FY09), making the case for a double-digit
increase stronger. However, we note state governments' revenues have not shown
any significant growth in the years of high excise increase as volumes were impacted.
The increase in excise duty on cigarettes has had a cascading impact on taxes as VAT is
imposed on cigarettes post-excise duty rates.
Specific excise duty on cigarette does not capture inflation impact
Cigarettes
YE
MRP (INR)
Exciseable sales
Excise Rate
Excise Duty
Volume (units)
Growth (%)
Total Excise
Excise Inc (%)
X
100
NA
INR2/stick
2
100
200
X+1
105
NA
INR2/stick
2
105
5
210
5.0
X
100
65
8%
5.2
100
FMCG
X+1
105
68
8%
5.5
105
5
520
573
10.3
Source: Company/MOSL
FICCI's budget expectations for tobacco industry
Continue with multiple price point, length-based specific excise duty structure.
Maintain tax stability in excise duty rates to leverage the tax efficiency of
cigarettes by encouraging shifts from non-cigarette forms of consumption. This
will maximize contribution to the exchequer, even in a shrinking basket of
overall tobacco consumption.
Revise the existing length slab for filter cigarettes not exceeding 60mm in length
to not exceeding 65mm in length with an excise duty levy of INR200/thousand
cigarettes. This would expand the tobacco tax base and combat the growing
menace of illicit INR1/per stick filter cigarettes.
Cigarette taxation under GST should be revenue-neutral with tax at the uniform
standard rate applicable to the general category of goods, with availability of
input tax Credit. While central excise duty would continue to be levied, it is
critical that the combined incidence of excise duty and GST on cigarettes remain
revenue neutral. This could be achieved by an appropriate reduction of the
extant rates of excise duty on cigarettes. Given the unsuitability of an ad-
valorem duty structure for a highly taxed product like cigarettes, GST should be
levied at specific rates.
Contain tax evasion by unscrupulous manufacturers through compulsory
licensing, stricter surveillance and harsher penalties.
12 March 2012
2

ITC
Bihar and J&K increase VAT on cigarettes; other states also expected to
follow
Bihar increased the VAT rate on cigarettes from 13.5% to 20%, while J&K from 25% to
30% in their FY13 budgets. In FY12, Maharashtra, Delhi, Rajasthan and Pondicherry
raised VAT on cigarettes from 12.5% to 20%. Out of the 6 six states that have already
presented their budget for FY13, only Bihar and J&K hiked VAT rate on cigarettes. The
remaining 4 left it unchanged. We do not rule out other states increasing the VAT rate
in their FY13 budgets. However, there is little incentive for states to increase the rate
beyond 20% as differential taxes in neighboring states would lead to increased
cigarette smuggling and loss of revenue. The average VAT rate for ITC has increased
from 18.2% in FY12 to 18.5% post the recent budgets in states. We don't rule out
another 100-150bp increase in the VAT rate. We estimate that ITC needs to raise prices
by 0.8% for every 1% increase in the VAT rate.
J&K and Bihar have increased VAT for FY13
State
Andhra Pradesh
Bihar
Gujarat
Orissa
Madhya Pradesh
J&K
Haryana
Budget Date
17-Feb-12
24-Feb-12
24-Feb-12
24-Feb-12
28-Feb-12
5-Mar-12
5-Mar-12
Old rates (%)
20.0
13.5
25.0
25.0
13.0
25.0
20.0
Revised Rates (%)
Volume share (%)
20.0
13
20.0
3
25.0
3
25.0
1
13.0
3
30.0
1
20.0
4
Source: Company/MOSL
Cigarette volumes more resilient to price increase
ITC's cigarette volume growth is much more resilient now than it was a decade back.
During the past five years, there have been very sharp increases in the excise duty on
cigarettes (especially in FY09 and FY11). VAT was introduced for the first time in FY08
at 12.5% and the rate was hiked by 350bp in FY11. In FY09 and again FY11, when retail
prices rose by almost 20% due to higher taxes, volumes declined by 28-3%. Even in
FY08, when the excise duty was increased by 5% and VAT was first introduced, volumes
declined by only 0.7%. This compares favorably with the 8.4% decline in FY02 post the
~15% increase in taxes and prices.
Trend in cigarette volume growth and price increases suggest growing resilience
Volume
Growth (%)
0.0
-0.6
-2.4
0.5
-8.4
4.2
3.1
7.1
8.4
7.1
-0.7
-2.9
7.2
-2.8
7.0
Inc in Realization /
stick (%)
12.4
14.0
7.9
8.9
14.2
5.9
2.2
1.0
4.6
5.8
8.5
12.6
6.7
18.0
6.0
Inc in Taxes /
stick (%)
26.3
8.7
4.2
8.0
14.9
3.8
0.6
-1.7
3.6
3.0
5.4
8.3
-1.8
19.5
1.0
VAT rate
hike (%)
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
12.5
12.5
14.5
18.0
18.2
Source: Company/MOSL
3
FY98
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
12 March 2012

ITC
ITC has expanded margins as it has hiked price before changes in duty
structure
The hike in excise duty on cigarettes has had a cascading impact of taxes as VAT is
imposed on post-excise rates. We estimate that ITC needs to increase prices by 2.3%
for every 5% increase in the excise duty on cigarettes to maintain realizations/stick.
The price increase required to neutralize the impact of a 1% increase in the VAT rate
is ~0.8%. The company has been hiking prices at a rate higher than the increase in
duties and taxes. We note the excise duty has declined from 55% of sales in FY06 to
44.5% of sales in FY12E; this excludes the VAT impact as gross reported sales are net of
VAT payments. ITC's strong pricing power has enabled the company to not only
maintain, but expand EBIDTA margins by 240bp since FY06. We expect a similar trend
would be witnessed in the coming years as well.
Strong pricing power: excise proportion is coming down, margins are moving up
(%)
Excise as a % of Cigarette sales
Source: Company/MOSL
ITC has maintained cigarette segment's EBIT growth at 15%, even in bad
times
The cigarette segment posted 16.8% EBIT growth in FY11 and is expected to post ~20%
EBIT growth in FY12. ITC has been calibrating its price hikes and volume growth to
boost profits. During FY12 till date, it has hiked prices by ~6%, the latest one being 3
months back. Although we expect double-digit hike in excise duty on cigarettes in
FY13, we are confident the company would be able to pass on the hike in the form of
price increases and sustain ~15% EBIT CAGR.
ITC's cigarette EBIT increased by 15% CAGR over the past 10 years (INR/1,000 sticks)
Length (mm)
Micros
<60
Plains
61-70
Small Filter
<60mm
Filter - Regular
<70
Filter - Long
71-75
Filter - King
76-85
Filter - Extra large 86-100
Excise Duty Change (%)
VAT (%)
Volume Growth (%)
Excise (% of realisation)
Net Realisation Gr (%)
EBIT Growth (%)
12 March 2012
FY01
115
390
-
580
945
1,260
1,545
5
-
0.5
53
10.1
24.4
FY02
135
450
-
670
1,090
1,450
1,780
16
-
-8.4
54
13.3
6.0
FY03
135
450
-
670
1,090
1,450
1,780
0
-
4.2
54
8.8
13.6
FY04
135
450
-
670
1,090
1,450
1,780
0
-
3.1
52
4.5
5.7
FY05
135
450
-
670
1,090
1,450
1,780
0
-
7.1
51
4.5
12.6
FY06
150
495
-
740
1,200
1,595
1,960
10
-
8.4
54
5.9
18.3
FY07
158
520
-
777
1,260
1,675
2,058
5
-
7.1
53
9.1
17.1
FY08 FY09 FY10 FY11 FY12E FY13E
167
819
819
669
669
702
551 1,323 1,323 1,473 1,473 1,547
-
-
-
669
669
702
819
819
819
969
969 1,017
1,323 1,323 1,323 1,473 1,473 1,547
1,759 1,759 1,759 1,959 1,959 2,057
2,163 2,163 2,163 2,363 2,363 2,481
5Micros 391
0
11
0
5
Plains 140
RFC - 18
12.5
12.514.5 (avg) 14.5
18.0
18.0
-0.7
-2.9
7.2
-2.8
7.0
6.0
52
50
46
47
44
44
11.9
17.3
15.2
16.6
10.4
7.7
14.6
15.1
18.0
16.8
20.1
15.2
Source: Company/MOSL
4

ITC
Non-cigarette segments' EBIT up 26% in 9MFY12; outlook positive
The non-cigarette segments' EBIT grew 26% YoY during 9MFY12. All its non-cigarette
businesses, except the hotels business, contributed to this growth. The FMCG
segment's losses fell 22% and agri profits were up 18%, while paper profits increased
19% YoY.
Non Cigarette EBIT to grow at 20% CAGR over FY12-14E
Net Sales
Growth (%)
EBIT
5,286
EBIT Growth (%) 64.1
EBIT Margin (%)
8.6
FY06
61,618
FY07
80,072
30
6,891
30.4
8.6
FY08
FY09
FY10
FY11
FY12E
FY13E
FY14E
95,481 104,342 114,545 137,277 161,792 188,351 216,444
19
9
10
20
18
16
15
7,296
5,975
9,991 13,545 16,946 20,245 24,488
5.9
-18.1
67.2
35.6
25.1
19.5
21.0
7.6
5.7
8.7
9.9
10.5
10.7
11.3
Source: Company/MOSL
We believe the non-cigarette segments' EBIT will grow at 20% over FY12-14 due to the
following reasons:
ITC's processed foods business is profitable and we expect EBIT margins to improve
as the business gains scale and benefits of premiumization in biscuits start
accruing. This would result in significant reduction in losses over the coming two
years.
Hotels business should sustain gradual recovery; gains from commissioning of
new properties should also boost numbers.
Paper and paperboard division will gain from new 0.1mt paperboard unit from
FY13; this will enable 14% EBIT CAGR over FY12-14.
Agri business would gain from new leaf tobacco manufacturing facility in Mysore
and sustained demand for Indian tobacco. We estimate 15% EBIT CAGR for this
SBU over FY12-14.
Non-cigarette business is 54% of sales
Cigarettes account for dominant share of profits
Source: Company/MOSL
ITC has given best pre-budget returns since 2006
ITC's stock has appreciated by 4.2% over the past two months, and is the best pre-
budget returns since 2006. This performance is being partly driven by the strong stock
market rally since end December 2011. There are expectations of a double digit
increase in excise duty on cigarettes given the fiscal constraints of the Central
government.
12 March 2012
5

ITC
However, ITC has given negative returns (after budget) only on two occasions in the
past eight years; as the company has managed to pass on the increased duties given
the superior pricing power. The stock delivered a 46% return in the run-up to FY12
budget despite the 17% hike in excise duty. It has appreciated by 22.3% so far in the
current year.
ITC has given more than 27% CAGR return in past three years
2007
2008
2009
2009
2010
2011
2012
Stock return (%)
(0.43)
17.63
(10.76)
9.65
17.32
45.65
22.31
Excise hike (%)
10.3
5.0
5.0
43.7
-
17.1
-
VAT hike (%)
-
12.5
-
2.3
-
-
3.3
Source: Company/MOSL
ITC has given best pre-budget return since 2006
Source: Company/MOSL
We believe that any sharp correction in the stock price during the run-up to the budget,
or post the budget in case of sharp increase in excise duty is a good entry point. We
remain positive on the long-term growth potential in ITC's core cigarette business
and growing profitability of its non-cigarette businesses. We estimate 17% CAGR
over FY12-14. The stock trades at 22.5x FY13E EPS of INR9.2 and 19.2x FY14E EPS of
INR10.8. Maintain
Buy.
12 March 2012
6

ITC
Cigarettes volume growth trend
Cigarette segment's EBIT has registered 15% CAGR
Leaf tobacco exports account for 46% of agri business sales Packaged foods sales are growing at 20% CAGR
Dividend payout might sustain at higher rate
Strong growth and higher payout boosted returns ratios
Capex remains at 15-20% of operating cash flows
Cash and equivalents remain comfortable
Source: Company/MOSL
12 March 2012
7

ITC
Financials and Valuation
Income Statement
Y/E March
Net Sales
Operational Income
Total Revenue
Change (%)
Total Expenditure
EBITDA
Change (%)
Margin (%)
Depreciation
Int. and Fin. Charges
Other Inc. - Recurring
Profit before Taxes
Change (%)
Margin (%)
Tax
Deferred Tax
Tax Rate (%)
Profit after Taxes
Change (%)
Margin (%)
Reported PAT
2009
156,119
1,946
158,065
11.5
107,341
50,724
8.9
32.5
5,494
376
3,403
48,257
5.6
30.9
12,550
3,071
32.4
32,636
4.6
20.9
32,636
2010
181,532
2,392
183,924
16.4
120,619
63,305
24.8
34.9
6,087
820
3,756
60,153
24.7
33.1
20,511
968
32.5
40,610
24.4
22.4
40,610
2011
211,676
3,007
214,683
16.7
139,944
74,739
18.1
35.3
6,560
679
5,182
72,682
20.8
34.3
22,809
3
31.4
49,876
22.8
23.6
49,876
2012E
250,073
3,521
253,594
18.1
163,942
89,652
20.0
35.9
7,276
750
7,434
89,061
22.5
35.6
27,787
445
31.7
60,828
22.0
24.3
60,828
2013E
289,175
3,833
293,008
15.5
187,895
105,113
17.2
36.3
8,041
750
7,717
104,039
16.8
36.0
32,252
520
31.5
71,267
17.2
24.6
71,267
(INR Million)
2014E
331,399
4,176
335,575
14.5
213,110
122,465
16.5
37.0
8,806
750
8,960
121,868
17.1
36.8
37,779
609
31.5
83,480
17.1
25.2
83,480
Balance Sheet
Y/E March
Share Capital
Reserves
Net Worth
Loans
Deferred Liability
Capital Employed
Gross Block
Less: Accum. Depn.
Net Fixed Assets
Capital WIP
Investments
Curr. Assets, L&A
Inventory
Account Receivables
Cash and Bank Balance
Others
Curr. Liab. and Prov.
Account Payables
Other Liabilities
Provisions
Net Current Assets
Application of Funds
E: MOSL Estimates
2009
3,774
133,576
137,351
1,776
8,672
147,798
105,587
32,867
72,719
12,141
28,378
81,597
45,997
6,687
10,310
18,603
47,036
29,237
3,833
13,966
34,561
147,798
2010
3,818
136,826
140,644
1,077
7,850
149,571
119,679
38,255
81,424
10,090
57,269
81,279
45,491
8,581
11,263
15,945
80,491
34,449
7,859
38,183
788
149,571
2011
7,738
151,795
159,533
992
8,019
168,543
127,658
44,208
83,451
13,334
55,547
101,840
52,675
9,076
22,432
17,656
85,628
43,821
7,371
34,436
16,212
168,543
2012E
7,738
180,597
188,335
992
7,227
196,554
142,658
51,483
91,175
10,000
67,973
109,176
62,747
11,647
13,134
21,648
81,770
47,779
6,617
27,374
27,406
196,554
2013E
7,738
214,342
222,080
992
6,327
229,399
157,658
59,524
98,135
10,000
92,073
123,503
71,511
13,468
14,594
23,930
94,311
54,627
7,613
32,071
29,191
229,399
(INR Million)
2014E
7,738
253,869
261,607
992
5,302
267,901
172,658
68,329
104,329
10,000
124,392
137,530
79,888
15,435
15,673
26,534
108,350
62,018
8,765
37,567
29,180
267,901
12 March 2012
8

ITC
Financials and Valuation
Ratios
Y/E March
Basic (INR)
EPS
Cash EPS
BV/Share
DPS
Payout %
Valuation (x)
P/E
Cash P/E
EV/Sales
EV/EBITDA
P/BV
Dividend Yield (%)
Return Ratios (%)
RoE
RoCE
Working Capital Ratios
Debtor (Days)
Asset Turnover (x)
Leverage Ratio
Debt/Equity (x)
2009
8.6
10.1
18.2
3.7
49.9
2010
10.1
11.7
18.4
10.0
115.1
2011
6.4
7.3
20.6
4.5
80.2
2012E
7.9
8.8
24.3
3.5
52.7
2013E
9.2
10.2
28.7
4.1
52.7
2014E
10.8
11.9
33.8
4.9
52.7
32.1
28.4
7.2
20.4
10.0
2.1
26.3
23.5
6.1
17.0
8.5
1.7
22.5
20.2
5.2
14.2
7.2
2.0
19.2
17.4
4.4
11.9
6.1
2.3
25.3
32.8
27.8
38.5
33.2
42.9
35.0
45.1
34.7
45.6
34.5
45.7
16
1.1
15
1.2
15
1.3
15
1.3
16
1.3
16
1.2
0.0
0.0
0.0
0.0
0.0
0.0
Cash Flow Statement
Y/E March
OP/(loss) before Tax
Int./Div. Received
Depreciation and Amort.
Interest Paid
Direct Taxes Paid
Incr in WC
Diff in dep
CF from Operations
Extraordinary Items
Incr Decr in FA
Pur of Investments
CF from Invest.
Issue of shares
Incr in Debt
Interest Income
Interest Paid
Dividend Paid
Others
CF from Fin. Activity
Incr of Cash
Add: Opening Balance
Closing Balance
E: MOSL Estimates
12 March 2012
2009
48,257
3,403
5,494
376
15,622
2,648
535
32,990
0
16,862
-968
-15,894
448
-698
3,403
376
13,190
-2,075
-12,489
4,607
5,703
10,310
2010
60,153
3,756
6,087
820
21,480
-6,956
700
49,481
0
12,041
28,891
-40,933
7,207
-85
3,756
820
13,965
-3,688
-7,596
953
10,310
11,263
2011
72,682
5,182
6,560
679
22,812
1,827
607
50,707
0
11,224
-1,722
-9,502
5,220
0
5,182
679
38,182
-1,576
-30,035
11,170
11,263
22,433
2012E
89,061
7,434
7,276
750
28,232
32,919
0
28,501
1
11,666
12,427
-24,092
0
0
7,434
750
34,435
14,043
-13,708
-9,298
22,432
13,134
2013E
104,039
7,717
8,041
750
32,772
24,426
0
47,915
2
15,000
24,100
-39,098
0
0
7,717
750
27,373
13,049
-7,357
1,460
13,134
14,594
(INR Million)
2014E
121,868
8,960
8,806
750
38,389
31,228
0
52,848
3
15,000
32,319
-47,316
0
-992
8,960
750
32,070
20,400
-4,452
1,079
14,594
15,673
9

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