Here’s why CLSA is bullish on ITC; sees the stock Rs 265 levels in a year

The elephant may just have been prepping for a dance. ITC, the fast moving consumer goods (FMCG) stock that has relatively been comatose at a time when its peers the overall markets delivered a healthy return, may be on the verge of changing the shape of its business, suggests a recent note by CLSA.

The brokerage believes that the ITC’s FMCG business is firmly on path for a profitable scale-up expects this business vertical to deliver around 31 per cent compounded growth in earnings before interest, taxes, depreciation amortisation (Ebitda CAGR) over FY20-24 on the back of industry tailwinds, margin levers improving asset utilisation.

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Over the past four years, ITC’s FMCG business margin has risen 640 basis points (bps), which according to CLSA, is likely to improve over the next few years. That apart, renewed efforts in the home personal care business segment leveraging the increased demfor hygiene products should yield good results for the company over the next few years, the note said.

“ITC’s FMCG business is shaping up well for a K-shape acceleration with scale driving margin expansion even as capital intensity falls. We expect another 362 bps of margin expansion for the FMCG business. This should drive a doubling of its Ebitda to around Rs 27 billion (FY21: Rs 13 billion) ROCE to 20 per cent over FY21-24CL,” wrote Chirag Shah Nitin Gupta of CLSA in a recent report. They have a buy rating on the stock with a 12-month target price of Rs 265.

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At the bourses, however, the stock has been a laggard since the past one year in the Nifty FMCG pack, rallying just 12 per cent as compared to 30 per cent rally in the Nifty FMCG index 53 per cent rise in the Nifty 50, ACE Equity data show. (See table below) On Tuesday, the stock was among the top gainers on the BSE, rallying 2.3 per cent in intraday trade to hit a high of Rs 214.25.

Given the road ahead for the next few years, CLSA finds the stock valuations attractive at the current levels with a record-high PE discount to the FMCG average (57 per cent) a 6 per cent dividend yield.

“Falling capex, the asset-light model for its hotel business a sharp increase in its dividend payout (102 per cent for FY21) should progressively address investor concern over capital allocation. The FMCG business trades at 2.5x FY23 EV/sales (38x implied PE). Valuations are attractive for ITC to consider buyback ($3.7 billion of liquid assets),” CLSA said.

The risks

Despite these positives, some analysts remain cautious, especially given the share of cigarettes business (48 per cent) in the overall revenue mix for the company. An increase in illicit cigarettes, anti-smoking regulations, sharp goods & services tax/cess hikes, aggressive diversification in the healthcare sector are some of the risks CLSA cites to their positive view.

A similar view is shared by analysts at Edelweiss Securities, who believe the high incidence of taxation strict regulatory norms on cigarette usage in public packaging remain a threat.

“Growing contrabmarket of cigarettes also poses a significant threat for the cigarette business. Slowdown in the macro-economic environment is a major threat to hotels business. SUUTI stake sale is a likely overhang on the stock,” wrote Abneesh Roy Tushar Sundrani in a recent note.

ITC stock performance

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