ITC Shares Pare Gains Despite Motilal Oswal’s Upgrade To ‘Buy’
Motilal Oswal upgraded ITC to ‘buy’ from ‘neutral’, and raised price target to Rs 335 from Rs 265 apiece.
Shares of ITC Ltd. gained the most in more than two weeks after Motilal Oswal upgraded the stock to ‘buy’ citing resilience in cigarettes demand and revival in mobility benefiting the FMCG business.
Cigarette demand was quick to recover to the pre-pandemic levels after the second pandemic wave, the brokerage said in a June 15 report. “Our channel checks suggest that demand continues to remain robust. There has been relative stability with regard to taxes on cigarettes in recent years. This has enabled ITC to calibrate its price increases to avoid disrupting demand.”
The cigarette mix, it said, has been “getting richer, aided by innovation, improved local manufacturing of capsule cigarettes, and better last-mile reach”. “With lower raw material inflation and little evidence of downtrading so far, margin resilience is evidently superior to other consumer categories".
Also, as educational institutions reopened, the demand for notebooks and stationery (a margin-accretive category) has seen a revival, Motilal Oswal said. Out-of-home categories like biscuits and small juice packets are also seeing a recovery.
“While margin may be affected by steeply higher input costs, the price hikes given ITC’s leadership position, cost management, supply chain optimisation, and premiumisation may offer some cushion to margin,” it said. “Over the medium-term, the management targets double-digit growth in revenue and profit for the FMCG–others business.”
According to the brokerage, with average room rate and occupancy rates reverting to the pre-pandemic levels, the hotels business is expected to deliver a better performance than that over the previous two years. “While profitability may still be impacted, its lag on the overall business will reduce substantially.”
Motilal Oswal expects ITC to post 15% earnings compounded annual growth rate over FY22-24.
While valuations of global tobacco peers have been restored to their pre-pandemic levels, ITC still trades at a 27% discount to its January 2019 valuations of 25.4x one-year forward EPS, the brokerage said.
“We value ITC at 21x FY24E EPS, representing a 65% premium to its global peer average,” it said. “The premium multiples are justified, given its strong visibility over the medium-term and the defensive nature of its business, especially in a volatile macro environment.”
Shares of ITC rose as much as 1.7% intraday on Thursday. The stock, however, reversed gains and closed 1% lower in a weak market where the benchmarks closed at 52-week lows.
Of the 35 analysts tracking the company, 32 recommend a ‘buy’ and three suggest a ‘hold’, according to Bloomberg data. The average of the 12-month consensus price target implies an upside of 17.40%.
Other Key Highlights From Motilal Oswal Report:
Upgrades ITC to ‘buy’ from ‘neutral’, raises price target to Rs 335 from Rs 265, an implied upside of 27.18%.
Volume growth in cigarettes business would have been 3-4% compared to 1-2% over the previous decade.
With the intensity of further Covid-19 waves decreasing, we now expect cigarette volume growth of 3-4% over the next couple of years, especially if the tax incidence remains benign.
We don’t expect capex to have an annual run-rate of more than Rs 3,000 crore over the next three years. Of this, 35-40% will be allocated toward FMCG for creating new capacity. The paperboard segment will be allocated 25-30% of the capex. The agri business, digital, and sustainability investments will also be a focus area. Hotels will receive 10% of incremental capex, given ITC’s pivot to an ‘asset-right’ model.
Lower capex requirements should result in better free cash flow and higher payouts. ITC’s higher dividend yield (4-5%) makes it an ideal defensive bet in the current volatile interest rate environment.
Key Risks To Motilal Oswal’s Investment Case:
Further Covid-19 waves.
Steep increase in taxes on cigarettes.
Sharp increase in commodity costs.
Stake sale by the Government of India—It owns about 28% stake in ITC through various state-owned Insurance companies and the Unit Trust of India.