We maintain ‘buy’ on ITC with an SOTP-based price target of R393 as near-term prospects appear strong.
Consumer stocks in India trade at a considerable premium to corresponding peers elsewhere due to superior earnings growth prospects. A key driver of that relative prospect — higher demand growth — is missing in the case of cigarettes. This could call into question the valuation premium ITC trades at relative to other tobacco stocks at some point in time once other growth drivers, price & mix, plateau.
Demand for cigarettes in India has grown only slightly ahead of the global demand, unlike the vastly superior growth in other consumer items. Taxation has played its part. Prevalence of smoking is also down. ITC has managed strong earnings growth due to share gains and price increases and will likely do so in the near term, but long-term risks are real. Growth in cigarette consumption in India has been fairly lackluster — volumes have grown c.1-1.3% pa over 1980-2010, only slightly ahead of global growth rates (1%). In recent years (2010-13), volumes have mostly remained flattish.
Tax incidence on cigarettes in the country is fairly high and is almost entirely being passed on to the consumer. As a result, retail prices of cigarettes in India, relative to income levels, are among the highest in the world. Despite these constraints, ITC has managed to grow earnings at a remarkably consistent and strong pace of c.18-20% over the past 10-20 years.