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					                                                                                                                12 January 2012
                                                                                                     Update | Sector: Consumer


                                                                                                                       ITC
BSE SENSEX               S&P CNX
16,038                      4,831    CMP: INR204                           TP: INR230                                      Buy
                                       Tackling taxes
                                       Cigarette profits shrug off excise hikes; non-cigarette outlook strong
                                          Cigarette EBIT CAGR 15% since 2000 despite excise CAGR of 9.2%.
Bloomberg                  ITC IN         Only consumer company to benefit from INR depreciation
Equity Shares (m)        7,738.1          Non-cigarette EBIT to post 25% CAGR over FY11-13; Outlook positive
52-Week Range (INR)      216/149
                                          Strong cash flows and improving payout ratio positive; Maintain Buy
1,6,12 Rel. Perf. (%)    3/14/37
M.Cap. (INR b)           1,582.1       Cigarette EBIT CAGR 15% since 2000 despite excise CAGR of 9.2%: The ITC
M.Cap. (USD b)               30.6      stock gets a drubbing every year ahead of the Union Budget due to concerns over an
                                       increase in excise duty on cigarettes. However, ITC's cigarette EBIT posted 15%
Y/E March       2011 2012E 2013E       CAGR since 2,000 despite excise, VAT increases and regulatory changes. We believe
Sales (INR b)  211.7 250.5 289.7       increase in excise duty should not act as a drag as cigarettes are placed under
EBITDA (INR b) 74.7 89.9 105.4         specific excise duty, which does not cover the impact of inflation in duty collection
NP (INR b)      49.9 60.0 71.0
                                       unlike in other products. Excluding the impact of a sharp increase in excise on micros
EPS (INR)        6.4   7.8   9.2
EPS Gr. (%)     27.3 20.3 18.4
                                       and plains in FY09, excise has increased in line with WPI. However we believe VAT is
BV/Sh. (INR)    20.6 24.3 28.6         a key factor because (1) it is an ad valorem tax and has a greater cascading impact
P/E (x)         31.7 26.4 22.3         and (2) VAT has a wide range of 12.5-40% as it is a state subject. ITC has already
P/BV (x)         9.9   8.4   7.1       taken a pre-emptive price increase of 2% in the month of December.
EV/EBITDA (x)   20.1 16.7 14.0
EV/Sales (x)     7.1   6.0   5.1       State taxes on non-cigarette tobacco are steps in the right direction: Currently
RoE (%)         33.2 34.5 34.7         excise on cigarettes is 25x the excise duty on bidis as cigarettes are looked on as
RoCE (%)        42.9 45.3 45.8         being harmful. In FY12 some states imposed VAT on non-cigarette tobacco at par
                                       with cigarettes and a few states increased it significantly. Imposition of a similar
Shareholding pattern % (Sep-11)        strategy at the excise duty level can have far-reaching implications on government
                                       revenue and growth in cigarettes. We expect volume growth in cigarettes to accelerate
   Domestic             Foreign
  Inst., 35.2
                                       as it becomes a preferred tobacco option for the younger generation. We model 7%
                         47.2
                                       and 6% volume growth for ITC in FY12 and FY13 respectively with 17% EBIT CAGR.

                                       Non-cigarette EBIT to post 25% CAGR over FY11-13; INR depreciation to provide
                                       upside: ITC is the only consumer company to benefit from INR depreciation due to
                                       net exports of INR18b and higher margins in paper. We estimate for every 1%
                                       depreciation of the INR, ITC EPS will increase by 0.4%. ITC posted non-cigarette
   Others,
                                       EBIT of 25% CAGR over the past five years and EBIT of 27.4% in 1HFY12. We
    17.6
                                       estimate 25% CAGR in ITC's non-cigarette business over FY11-13, driven by 31%
                                       CAGR in loss reduction in FMCG, EBIT of 22% CAGR in hotels and EBIT of 15-17%
                                       CAGR in paperboards and the agri business.
Stock performance (1 year)
                                       Strong cash flow, improving payout ratio positive; Maintain Buy: ITC's dividend
         ITC     Sensex - Rebased
220                                    payout jumped from 45-50% until FY09 to 115% and 80% in FY10 and FY11
                                       respectively, due to payment of one-time dividend. We believe there is a strong case
195                                    for ITC's dividend payout ratio being higher than in the past as (1) capex as a proportion
                                       of cash flows declined from 62% to current levels of 18-19% and (2) ITC's cash and
170
                                       liquid investment will increase to INR95b from INR67b at a payout ratio of ~50%. We
145
                                       expect ITC to post 19% PAT CAGR over FY11-13 powered by 17% growth in cigarette
                                       EBIT and 24% EBIT growth in its non-cigarette businesses. Upside to estimates can
120                                    come from (1) higher volume growth in cigarettes, (2) gains from rupee depreciation in
  Jan-11 May-11 Sep-11 Jan-12          the agri and paper and (3) faster recovery of the hotels business. The stock trades at
                                       26.4x FY12E EPS and 22.3x FY13E EPS. Maintain Buy with a target price of INR230.
Amnish Aggarwal (AmnishAggarwal@MotilalOswal.com) + 91 22 3982 5404
Harit Kapoor (Harit.Kapoor@MotilalOswal.com)+ 9122 3029 5120
                                                                                                                                                ITC



                                     Cigarette EBIT CAGR 15% over 10 years despite excise
                                     increases

                                     Every year, the fear of a sharp increase in excise duty on cigarettes depresses the ITC
                                     stock. This year, those fears are likely to intensify after an excise increase holiday in the
                                     2011 Union Budget, even though VAT increased by 3.5% in FY12. This follows the
                                     government's rising fiscal constraints amid lower forecast of economic growth. We analyze
                                     excise duty trends and their impact on government revenue collection and ITC's growth
                                     over the past decade.

         Specific excise duty        A case for gradual increase in excise duty: Excise duty on cigarettes is specific and
  does not captures inflation        not ad valorem, as is the case for most consumer products. This means excise collections
        in excise collections        are a function of cigarette volumes and not price. In a given year, the increase in excise
                                     collection is a function of cigarette volume growth, given a stable excise duty. A 5%
                                     volume growth in cigarettes and a 5% increase in MRP would result in a 10.3% increase
                                     in excise collections if calculated on an ad valorem basis like other FMCG products.
                                     Hence, we believe a moderate increase in excise duty would enable the government to
                                     offset the loss to the exchequer due to specific excise duty on cigarettes.

                                     Specific excise duty does not capture inflation in cigarette prices
                                                                             Cigarettes                                           FMCG
                                     YE                                 X                  X+1                        X                   X+1
                                     MRP (INR)                         100                  105                     100                   105
                                     Exciseable sales                   NA                   NA                      65                    68
                                     Excise Rate (INR/Stick)             2                    2                     8%                    8%
                                     Excise Duty                         2                    2                      5.2                   5.5
                                     Volume (units)                    100                  105                     100                   105
                                       Growth (%)                                             5                                              5
                                     Total Excise                      200                  210                     520                   573
                                       Excise Inc (%)                                       5.0                                          10.3
                                                                                                                            Source: Company/MOSL


       Excise duty rates have        Excise duty increase slightly ahead of inflation: Our analysis of data over the past 10
    increased by 9.2% CAGR           years indicates that CAGR in excise duty rates was 9.2%, whereas WPI inflation was
                                     5.8%. If we remove FY09 from the sample as the year had an abnormal 390% and 140%
                                     increase in duty on micros and plains respectively, the CAGR of cigarette excise would be
                                     only 5.8%, in line with inflation. We note that excise duty outgo on the cigarette industry
                                     increased by 8.7% CAGR over the past 10 years and the share of excise on cigarettes in
                                     total excise collections increased by 310bp.


Cigarette excise CAGR was 9.2% over the past 10 years and WPI inflation was 5.8%. Excluding FY09, excise on cigarettes
was in line with the WPI inflation
                                 FY01     FY02     FY03        FY04     FY05    FY06      FY07    FY08     FY09            FY10     FY11 CAGR (%)
Excise Duty Change (%)              5.0    15.5       0.0       0.0      0.0     10.0       5.0     5.0     43.7         0.0     17.0    9.2
Cigarette Excise (INRb)           40.3     42.8     46.9       48.0     51.0     61.0      67.6    71.9     75.6        79.6     92.5    8.7
Increase %                          6.4      6.2      9.6       2.3       6.4    19.5      10.9      6.4      5.1         5.3    16.2
WPI Inflation %                     7.1      3.6      3.4        5.5      6.5      4.4      6.5      4.8      8.0         3.6     9.9    5.8
Cigarette Industry Excise (INR b) 50.3     53.5     58.6       60.0     63.8     76.2      84.5    89.9     94.5        99.5   115.7     8.7
Indian Excise duty (INRb)          619      685      726        823      908      991     1,112   1,176    1,236       1,086   1,030     5.2
Cigarette Excise proportion %       8.1      7.8      8.1        7.3      7.0      7.7      7.6      7.6      7.6         9.2    11.2
                                                                                                                         Source: Company/MOSL

12 January 2012                                                                                                                                  2
                                                                                                                           ITC



                                 Years of moderate excise increase have worked best for the exchequer as the increase in
                                 excise collections captured the excise duty increase and volume growth. Conversely, a
                                 sharp increase in duty resulted in volume pressure and less than proportionate benefits.
                                 We believe an increase in excise duty, in line with inflation, is here to stay and should not
                                 be perceived as a big drag for ITC.

                                 Rising VAT increases cascading impact of taxes
      560bp increase in VAT      Cigarettes face several taxes at the state level. The taxes include octroi, VAT, luxury
        rates over FY08-12E      taxes and others that have a different nomenclature in different states. VAT was introduced
                                 from FY08 at a flat rate of 12.5% across India. However VAT rates today vary between
                                 12.5-40%. We estimate VAT revenue for states increased from INR21b in FY08 to INR37b
                                 in FY11 and we estimate it will be INR50b in FY12. The average VAT rate increased
                                 from 12.5% to current levels of 18.1%. The rising VAT rate has been detrimental to the
                                 cigarette industry's volume growth as VAT is applicable on an ad-valorem basis after
                                 excise duty and has much more impact on duties and product pricing.
                                 VAT on cigarettes increased by 330bp in FY12 (%)

                                                                                                                   18.1


                                                                                              14.8
                                                                             14.0

                                           12.5            12.5




                                         FY08              FY09              FY10              FY11              FY12E


                                                                                                          Source: Company/MOSL


                                 State taxes on non-cigarette tobacco, GST to offer relief to tobacco industry
        Share of cigarettes in   The world over, governments have aimed at increasing their revenue by targeting cigarettes
    tobacco consumption has      as social concerns offer little resistance to tax increases. However, India has one of the
fallen from 23% to 14% over      lowest ratios of cigarette consumption to total tobacco consumption, which significantly
            the past 40 years    negates the benefits of an excise increase on cigarettes. The share of cigarettes in tobacco
                                 consumption has fallen from 23% to 14% over the past 40 years, even as less taxed
                                 products have grown fast.
                                 Cigarette contribution to total tobacco consumption negates benefits of high duty on
                                 cigarettes (%)

                                             23                21                20
                                                                                                     17
                                                                                                                      14




                                         FY72              FY82              FY92              FY03               FY10

                                                                                                          Source: Company/MOSL

12 January 2012                                                                                                             3
                                                                                                                                ITC



   States recently increased     Since 1982, tobacco consumption through cigarettes declined by 14% but more than doubled
     taxes on non cigarettes     through other products. We note that excise duty on the cheapest cigarette is ~25x the
 tobacco which is a positive     duty charged on bidis. However state governments have started realizing the impact of
      trend for the cigarette    this anomaly on the exchequer. Several states increased VAT on bidis and other tobacco
                     industry    products, in addition to taxes on cigarettes. In J&K, Gujarat, Himachal Pradesh, Karnataka
                                 and Rajasthan, VAT on bidis is on par with VAT on cigarettes and Delhi and Tamil Nadu
                                 introduced VAT on bidis. We expect more states to tax non-cigarette tobacco products at
                                 par with cigarettes.

                                 Although in India, bidis outsell cigarettes 10x, in neighboring developing countries such as
                                 Pakistan, Bangladesh and Sri Lanka, cigarettes dominate tobacco consumption. We believe
                                 the trend of increasing taxes on bidis, can significantly increase excise collections.

                                 The various state taxes, put together, would average about 20% of cigarette revenue on
                                 an ad valorem basis. Imposition of a fixed GST, at 20%, which subsumes all the taxes, can
                                 provide relief to the tobacco industry as multiplicity of taxes would be removed.

                                 Long-term outlook positive; Lower price differential can accelerate growth
                                 A combination of rising incomes, rural awareness, higher literacy and a young population
                                 augurs well for growth of the cigarette industry in the coming years. Growth rates can be
                                 far higher and surprise positively if regulatory action can cut the price differential between
                                 cigarettes and bidis, which is currently 3-5x at the lower level. As such, we expect volume
                                 growth to accelerate as the young population prefers cigarettes. With half the population
                                 below 24 years and a likely addition of a large pool of young consumers (born after 2000)
                                 into the smoking age, growth rates should accelerate.
                                 Age profile and preference of the tobacco consumer
   Younger consumers prefer                              Any              Cigarettes              Bidi               Proportion %
 cigarettes to bidis, which is   15-24                    5.3                3.4                   2.2                    64.2
                                 25-44                   14.9                6.5                   9.8                    43.6
    positive for the cigarette
                                 45-64                   22.0                7.6                  15.7                    34.5
                      industry   65+                     20.3                4.9                  14.8                    24.1
                                                                                                                 Source: GATS/MOSL

                                 Education profile and preference of the tobacco consumer
  Higher the education level,                            Any              Cigarettes              Bidi               Proportion %
                                 No schooling            16.9                4.4                  12.9                    26.0
        higher the incidence
                                 <class 5                20.3                6.6                  15.3                    32.5
        of cigarette smoking     Class5-10               12.9                6.3                   8.1                    48.8
                                 >class 10                8.9                6.3                   3.4                    70.8
                                                                                                                 Source: GATS/MOSL

                                 Average monthly expenditure on cigarettes and bidis
        The average monthly                      Avg Monthly           Rural           Urban            No         >Secondary
  expenditure is 33% higher                     Expense (INR)                                    Schooling

for cigarettes in urban areas    Cigarettes             399.3          347.5           469.0             307.6             462.1
                                 Bidis                   93.4           98.0            92.5              93.3              84.4
                                                                                                                 Source: GATS/MOSL
        The average monthly
        expenditure on bidis     Monthly Expense (INR)/Age
                                                                           15-17                18-24                     >24
    increases with age but it
                                 Cigarettes                                    670                303                      412
       declines in the case of   Bidis                                          41                 70                       95
                    cigarettes                                                                                   Source: GATS/MOSL


12 January 2012                                                                                                                  4
                                                                                                                                    ITC



                                  Cigarettes post EBIT of 17% CAGR despite an unfavorable
                                  operating environment
 Resilient growth in a tough      ITC's cigarette business posted EBIT of 14.8% CAGR since 2000, but only on two
    regulatory environment        occasions was it in single digits. The last time ITC's cigarette business had single digit
                                  EBIT growth was in 2004, after which it faced major headwinds, such as:

                                       FY08: VAT introduction in cigarettes.
                                       FY09: A 371% and 140% increase in excise duty on micros and plains respectively.
                                        ITC then exited the segments, which accounted for 15% of its volumes.
                                       FY10: A 2% increase in average VAT, pictorial warnings on cigarette packets became
                                        mandatory.
                                       FY11: A 17% increase in excise duty.
                                       FY12: A 3.5% increase in the average VAT rate.

                                  The headwinds resulted in FY11 cigarette volumes being higher by only 0.6% over FY07
                                  levels but realization per stick increased by ~50%. Consequently, ITC's cigarette business
                                  posted EBIT CAGR of 17% over FY07-11. ITC showed commanding pricing power,
                                  raising its cigarette prices to pass on the entire increase in duty to the consumer, thus
                                  maintaining healthy profit growth.


ITC's cigarette EBIT increased by 15% CAGR over the past 10 years (INR/1,000 sticks)
               Length (mm)      FY01    FY02    FY03    FY04    FY05    FY06    FY07    FY08    FY09    FY10     FY11   FY12E FY13E
Micros                   <60      115     135     135     135     135     150     158     167       819     819      669     669    702
Plains                 61-70      390     450     450     450     450     495     520     551 1,323 1,323 1,473 1,473 1,547
Small Filter         <60mm          -       -       -       -       -       -       -        -         -       -     669     669    702
Filter - Regular         <70      580     670     670     670     670     740     777     819       819     819      969     969 1,017
Filter - Long          71-75      945   1,090   1,090   1,090   1,090   1,200   1,260   1,323 1,323 1,323 1,473 1,473 1,547
Filter - King          76-85    1,260   1,450   1,450   1,450   1,450   1,595   1,675   1,759 1,759 1,759 1,959 1,959 2,057
Filter - Extra large 86-100     1,545   1,780   1,780   1,780   1,780   1,960   2,058   2,163 2,163 2,163 2,363 2,363 2,481
Excise Duty Change (%)              5      16       0       0       0      10       5        5Micros 391       0       11       0      5
                                                                                               Plains 140        RFC - 18
VAT (%)                             -       -       -       -       -       -       -    12.5      12.514.5 (avg) 14.5      18.0   18.0
Volume Growth (%)                 0.5    -8.4     4.2     3.1     7.1     8.4     7.1     -0.7      -2.9     7.2    -2.8      7.0    6.0
Excise (% of realisation)          53      54      54      52      51      54      53       52        50     46       47      44     44
Net Realisation Gr (%)           10.1    13.3     8.8     4.5     4.5     5.9     9.1    11.9      17.3    15.2     16.6    10.4     7.7
EBIT Growth (%)                  24.4     6.0    13.6     5.7    12.6    18.3    17.1    14.6      15.1    18.0     16.8    20.1   15.2
                                                                                                                   Source: Company/MOSL



         High entry barriers      We believe the rising influence on consumption patterns of the generation born post-2000
 strengthen ITC's position in     will result in increasing cigarette consumption as a part of total tobacco usage. We believe
       the cigarette industry     ITC is uniquely placed to gain from the unfolding opportunity in the Indian cigarette industry
                                  over the coming decade, as a ban on FDI in tobacco will prevent other global players from
                                  entering a high potential consumer market. ITC will thus have the lion's share of growth in
                                  the Indian tobacco industry over the next decade. We factor in volume growth of 7% in
                                  FY12 and 6% in FY13 and EBIT growth of 19.7% in FY12 and 14.6% in FY13. We
                                  believe ITC will settle for lower volumes and higher margins in cigarettes for mid-teen
                                  EBIT growth, if cigarette excise is increased by more than 10-12%.



12 January 2012                                                                                                                       5
                                                                                                                                     ITC



                                Non-cigarette EBIT to post 25% CAGR over FY11-13; INR depreciation to
                                provide upside
                                ITC is the only consumer company to benefit from INR depreciation due to net exports of
                                INR18b and higher margins in paper. We estimate for every 1% depreciation of the INR,
                                ITC EPS will increase by 0.4%. ITC posted non-cigarette EBIT of 25% CAGR over the
                                past five years and EBIT of 27.4% in 1HFY12. We estimate 25% CAGR in ITC's non-
                                cigarette business over FY11-13, driven by 31% CAGR in loss reduction in FMCG, EBIT
                                of 22% CAGR in hotels and EBIT of 15-17% CAGR in paperboards and the agri business.

                                ITC's non-cigarette business: Agri and paperboards business change fortunes
                                                     FY06       FY07        FY08        FY09           FY10      FY11    FY12E    FY13E
                                Net Sales           61,618     80,072      95,481    104,342     114,545      137,277 159,841 186,035
                                  Growth (%)                        30          19          9         10            20        16       16
                                EBIT                 5,286      6,891       7,296      5,975       9,991       13,545    16,850   21,331
                                  EBIT Growth (%)     64.1       30.4          5.9     -18.1        67.2         35.6        24.4    26.6
                                  EBIT Margin (%)      8.6         8.6         7.6        5.7         8.7          9.9      10.5     11.5
                                                                                                                     Source: Company/MOSL


                                Paperboard and paper: ITC will commission its paperboard capacity expansion by 0.1mt
                                in 1QCY12, which will strengthen its leadership in the value-added paperboard market.
                                ITC's paper division is backward integrated (80-85%); with the depreciating INR and
                                hence increasing landed cost of pulp, margins are likely to benefit. We estimate EBIT of
                                15.5% CAGR in ITC's paperboard segment over FY11-13, aided by a 70bp margin
                                expansion.

                                Paperboards: Capacity expansion to accelerate growth in FY13
                                                       FY07        FY08          FY09           FY10          FY11      FY12E    FY13E
                                Net Sales (INR m)    19,106      21,579        26,471      31,078         35,072       39,631    45,340
                                  Growth (%)             7.5       12.9          22.7        17.4           12.9          13.0      14.4
                                EBIT (INR m)          4,168       4,531         5,086       6,843          8,192        9,130    10,920
                                  Growth (%)           18.6          8.7         12.2        34.5           19.7          11.4      19.6
                                  EBIT margin (%)      21.8        21.0          19.2        22.0           23.4          23.0      24.1
                                                                                                                     Source: Company/MOSL


         FMCG Others losses     FMCG: ITC's new FMCG losses declined by 15% in 1HFY12 mainly due to rising
    declined 15% in 1HFY12      profitability in the foods portfolio and lower losses in lifestyle retailing. Its incremental
                                sales yielded lower margins due to high input costs and rising competition. Besides, ITC
                                continues to achieve mid single-digit EBITDA margins in the stationery business and
                                expects breakeven for the entire business by FY13. However, we believe this is a tall
                                order given the competitive intensity and material price inflation in processed foods and
                                personal care.

  ITC is now the No 2 player       Processed foods: ITC's processed foods business achieved EBITDA breakeven at
           in instant noodles       the SBU level after Bingo broke even. Yippee instant noodles have been a success
                                    and ITC has shifted its focus from market share to the higher margin cookies-and-
                                    creams segment in the biscuits segment. We expect ITC's processed foods business
                                    to post sales of INR40b by FY13, but we note that over the longer term, stable EBIT
                                    margins in the business will be in mid to high single digits, given highly competitive
                                    categories.



12 January 2012                                                                                                                          6
                                                                                                                                                              ITC



Revenue CAGR of 35% over FY06-11                                         Incremental margins over sales

                     Packaged Foods sales (INR m)               39,957                     Incr Sales (INR m)                 Incr EBIT Margin (%)
                                                       34,000                              9.3
                                              28,937
                                                                                                         6.8                                6.6
                                     23,173                                                                          5.7
                            19,385                                           4.3                                                                     3.8
                   17,171

          10,834
  6,567                                                                     2,462        1,944        2,124        1,896            1,954         2,876




                                                                              1QFY11




                                                                                            2QFY11




                                                                                                         3QFY11




                                                                                                                     4QFY11




                                                                                                                                       1QFY12




                                                                                                                                                     2QFY12
  FY06     FY07    FY08      FY09    FY10      FY11     FY12    FY13


                                                                                                                                 Source: Company/MOSL

                                        Personal care: ITC achieved 6% market share by volume in the toilet soaps segment
                                         and the response to Vivel fairness cream has been encouraging. However, it is tweaking
                                         its formulations in shampoos. ITC also entered the talcum powder market under the
                                         Vivel brand. We believe ITC has a long way to go before it gets a firm foothold in this
                                         segment.

                                     FMCG Others: 31% CAGR in loss reduction over FY11-13
                                                                 FY07     FY08          FY09          FY10         FY11             FY12E         FY13E
                                     Net Sales (INR m)          16,895   25,096        30,056        36,339       44,716           54,068    63,003
                                       Growth (%)                 66.7     48.5          19.8          20.9         23.1              20.9      16.5
                                     EBIT (INR m)               -2,020   -2,635        -4,835        -3,495       -2,976           -2,163     -1,386
                                                                                                                                 Source: Company/MOSL


            Delayed recovery         Hotels: The hotel industry is recovering slowly as weak economic conditions in Europe
            expected in hotels       and the US impacted tourist arrivals. Occupancies are flat due to an increasing supply and
                                     ARR (average revenue per room) has not picked up meaningfully. ITC will commission a
                                     600-room property in Chennai in 2HFY12. Construction of properties in Gurgaon and
                                     Kolkata is progressing per schedule. We expect macro headwinds to result in a slow,
                                     delayed recovery for the segment and estimate EBIT of 22% CAGR over FY11-13.

                                     Hotels: Slow recovery likely, uncertain economy a key headwind
                                                                 FY07     FY08          FY09          FY10         FY11             FY12E         FY13E
                                     Net Sales (INR m)           9,058   10,121         9,355         8,507       10,008           11,216    12,673
                                       Growth (%)                 30.8     11.7           -7.6          -9.1        17.6              12.1      13.0
                                     EBIT (INR m)                3,508    4,108         3,162         2,166        2,666            3,292      3,995
                                       Growth (%)                 35.9     17.1         -23.0         -31.5         23.0              23.5      21.4
                                       EBIT Margin (%)            38.7     40.6          33.8          25.5         26.6              29.3      31.5
                                                                                                                                 Source: Company/MOSL


     Margins to benefit from         Agri business: ITC transformed its agri business, which posted an 850bp increase in
        rupee depreciation           EBIT margins and a 3.4x increase in profits over FY08-11. ITC significantly revamped
                                     the agri business, shifting away from low margin commodity trading to high margin leaf
                                     tobacco exports. External agri sales increased by only 14% from INR24b in FY08 to
                                     INR27b in FY11, but leaf tobacco sales were up 125% from INR5b to ~INR13b.




12 January 2012                                                                                                                                                7
                                                                                                                         ITC



                              Consequently leaf tobacco's share in external sales rose from 21% to 46%. Volumes
                              increased 22% over the past three years and realizations more than doubled, boosting
                              sales and profitability. ITC is setting up a leaf tobacco processing unit near Mysore, which
                              will increase volumes and help to save on logistics costs. We expect strong, sustained
                              global demand for Indian leaf tobacco, which will enable steady growth for the agri business
                              in the coming years. The depreciation of the rupee will boost profit and margins.

Agri business sales mix: Leaf tobacco increases from 21% to 46% of external sales

                             FY08                                                       FY11
                                                                                                        Soya
      Others
                                                                                                        26%
       22%
                                                                Others
                                                                 16%

                                                     Soya
  Coffee                                             48%
   9%
                                                              Coffee
                                                               12%
                                                                                                                 Leaf
         Leaf                                                                                                  Tobacco
       Tobacco                                                                                                   46%
         21%

                                                                                                        Source: Company/MOSL

                              The agri business: Rupee depreciation, a new leaf-tobacco unit to boost growth
                                                     FY07      FY08       FY09      FY10        FY11      FY12E      FY13E
                              Net Sales (INR m)    35,013    38,684      38,460    38,621      47,480     54,926    65,018
                                Growth (%)           30.7      10.5         -0.6       0.4       22.9        15.7      18.4
                              EBIT (INR m)          1,236     1,292       2,562     4,478       5,663      6,591      7,802
                                Growth (%)           36.0        4.6       98.3      74.8        26.5        16.4      18.4
                                EBIT margin (%)        3.5       3.3         6.7     11.6        11.9        12.0      12.0
                                                                                                        Source: Company/MOSL




12 January 2012                                                                                                              8
                                                                                                                                            ITC



                                        Valuation and view: Strong cash flow, improved payout
                                        ratio positive; Maintain Buy

                                        ITC's dividend payout jumped from 45-50% until FY09 to 115% and 80% in FY10 and
                                        FY11, respectively, mainly due to payment of one-time dividend in both years. We believe
                                        there is a strong case for ITC's dividend payout ratio to be higher than in the past, though
                                        it is unlikely to be as high as it was in FY10 and FY11. This is because:
                                         Operating cash flows nearly doubled over the past three years and capex increases
                                             have not been commensurate with operating cash flows. Capex as a proportion of
                                             cash flow declined from 62% to current levels of mid to high teens.
                                         ITC had cash and liquid investments of INR67b as on March 2011, which will increase
                                             to INR95b in FY13 at a payout ratio of ~50%.

Capex is only 18% of cash flows                                            Cash position remains strong

                        Operating Cash flow s (INR b)                                Cash and Liquid Investm ents (INRb)                   95
                        Capex as a % of Op cash flow s
                                                                      84
             62          62                                                                                                 67      69
                                                                                                                   58
                                             60    65      63
                                 42
                                                                               36
                                                                                         31              30
    23                                       20                                                    26
                        34                         17     18          18
                                 40
               25
     23


    FY06     FY07      FY08     FY09     FY10     FY11   FY12E FY13E          FY06      FY07   FY08     FY09      FY10     FY11 FY12E FY13E


Dividend payout higher in FY10 and FY11                                    Return ratios inch up

                    DPS (INR)            Dividend payout ratio (%)                       RoE (%)               RoCE (%)
                                                                                                                                   45.3    45.7
                                       115                                                                                42.9
                                                  4.5                                                           38.5
                                         5.0                         4.1
                                                                              35.7     35.9    35.3
                                                         3.5
                                                                                                        32.8
                                                   80
                                                                                                                            33.2    34.5   34.6

                        1.8     1.9
              1.6                                                            27.5       27.4   27.7                27.8
     1.3                                                  53         53
                        49                                                                              25.3
               51               50
     48


    FY06     FY07      FY08     FY09    FY10      FY11 FY12E FY13E           FY06      FY07    FY08     FY09     FY10     FY11     FY12E FY13E


                                                                                                                          Source: Company/MOSL



           Maintain Buy with a          We expect ITC to post 19% PAT CAGR over FY11-13, powered by 16% EBIT growth in
         target price of INR230         cigarettes and 24% EBIT growth in its non-cigarette businesses. Upside to estimates can
                                        come from (1) higher volume growth in cigarettes, (2) gains from a new leaf tobacco
                                        processing facility and (3) faster-than-expected recovery of its hotels business. The stock
                                        trades at 26.4x FY12E EPS of INR7.8 and 22.3x FY13E EPS of INR9.2. Maintain Buy
                                        with a target price of INR230.


12 January 2012                                                                                                                                 9
                                                                                                                                    ITC



Sales mix                                                     EBIT mix


                        Net Sales                                                      Paperboard        PBIT
                                                                                          12%
       Paperbord                                                                Agri
         14%                                                                    8%
                                              Cigarettes             Hotels
                                                 44%                  4%
        Agri
        20%                                                          FMCG
                                                                      4%

                                                                                                                       Cigarettes
               Hotels
                                                                                                                          81%
                4%
                                    FMCG
                                     18%

                                                                                                             Source: Company/MOSL



                             Sales growth and EBIT margins for various segments (INR m)
                                                    FY06     FY07      FY08            FY09     FY10      FY11     FY12E    FY113E
                             Net Sales
                             Cigarettes            51,050   58,949   66,350        77,807      93,212   105,737   126,670   143,784
                             FMCG                  10,135   16,895   25,096        30,056      36,339    44,716    54,068    63,003
                             Hotels                 6,926    9,058   10,121         9,355       8,507    10,008    11,216    12,673
                             Agri Business         26,784   35,013   38,684        38,460      38,621    47,480    54,926    65,018
                             Paperboards & Paper   17,773   19,106   21,579        26,471      31,078    35,072    39,631    45,340
                             Sales Growth (%)
                             Cigarettes              14.4     15.5       12.6          17.3      19.8      13.4      19.8      13.5
                             FMCG                    72.0     66.7       48.5          19.8      20.9      23.1      20.9      16.5
                             Hotels                  37.0     30.8       11.7          -7.6      -9.1      17.6      12.1      13.0
                             Agri Business           52.0     30.7       10.5          -0.6       0.4      22.9      15.7      18.4
                             Paperboards & Paper     12.0      7.5       12.9          22.7      17.4      12.9      13.0      14.4
                             EBIT
                             Cigarettes            27,088   31,722   36,340        41,838      49,381    57,668    69,035    79,081
                             FMCG                  -1,718   -2,020   -2,635        -4,835      -3,495    -2,976    -2,163    -1,386
                             Hotels                 2,581    3,508    4,108         3,162       2,166     2,666     3,292     3,995
                             Agri Business            909    1,236    1,292         2,562       4,478     5,663     6,591     7,802
                             Paperboards & Paper    3,514    4,168    4,531         5,086       6,843     8,192     9,130    10,920
                             EBIT Margin (%)
                             Cigarettes              53.1     53.8      54.8            53.8     53.0      54.5      54.5      55.0
                             FMCG                   -17.0    -12.0     -10.5           -16.1     -9.6      -6.7      -4.0      -2.2
                             Hotels                  37.3     38.7      40.6            33.8     25.5      26.6      29.3      31.5
                             Agri Business            3.4      3.5       3.3             6.7     11.6      11.9      12.0      12.0
                             Paperboards & Paper     19.8     21.8      21.0            19.2     22.0      23.4      23.0      24.1
                             EBIT Growth (%)
                             Cigarettes              18.3     17.1       14.6           15.1     18.0      16.8      19.7     14.6
                             FMCG                   -12.0     17.6       30.5           83.5    -27.7     -14.9     -27.3    -35.9
                             Hotels                  83.1     35.9       17.1          -23.0    -31.5      23.0      23.5     21.4
                             Agri Business           -5.8     36.0        4.6           98.3     74.8      26.5      16.4     18.4
                             Paperboards & Paper     25.5     18.6        8.7           12.2     34.5      19.7       11.4    19.6
                                                                                                              Source: Company/MOSL




12 January 2012                                                                                                                     10
                                                                                                         ITC



                  Financials and Valuation

                  Income Statement                                                              (INR Million)
                  Y/E March                   2008       2009       2010      2011     2012E         2013E
                  Net Sales                139,475    156,119    181,532   211,676   250,529       289,668
                  Operational Income         2,345      1,946      2,392     3,007      3,521         3,833
                  Total Revenue            141,820    158,065    183,924   214,683   254,050       293,501
                     Change (%)               15.6        11.5      16.4      16.7       18.3          15.5
                  Total Expenditure         95,231    107,341    120,619   139,944   164,104       188,070
                  EBITDA                    46,589     50,724     63,305    74,739    89,946       105,431
                     Change (%)               14.8         8.9      24.8      18.1       20.3          17.2
                     Margin (%)               33.4       32.5       34.9      35.3       35.9          36.4
                  Depreciation               4,385      5,494      6,087     6,560      7,276         8,041
                  Int. and Fin. Charges        251        376        820       679        750           750
                  Other Inc. - Recurring     3,764      3,403      3,756     5,182      6,183         7,189
                  Profit before Taxes       45,717     48,257     60,153    72,682    88,103       103,830
                     Change (%)               17.3         5.6      24.7      20.8       21.2          17.9
                     Margin (%)               32.8       30.9       33.1      34.3       35.2          35.8
                  Tax                       13,690     12,550     20,511    22,809    27,664        32,291
                  Deferred Tax                 827      3,071        968         3        441           519
                     Tax Rate (%)             31.8       32.4       32.5      31.4       31.9          31.6
                  Profit after Taxes        31,201     32,636     40,610    49,876    59,998        71,020
                     Change (%)               16.8         4.6      24.4      22.8       20.3          18.4
                     Margin (%)               22.4       20.9       22.4      23.6       23.9          24.5
                  Reported PAT              31,201     32,636     40,610    49,876    59,998        71,020

                  Balance Sheet                                                                 (INR Million)
                  Y/E March                   2008       2009       2010      2011     2012E         2013E
                  Share Capital              3,769      3,774      3,818     7,738      7,738         7,738
                  Reserves                 116,808    133,576    136,826   151,795   180,204       213,831
                  Net Worth                120,577    137,351    140,644   159,533   187,942       221,570
                  Loans                      2,144      1,776      1,077       992        992           992
                  Deferred Liability         5,451      8,672      7,850     8,019      7,232         6,333
                  Capital Employed         128,172    147,798    149,571   168,543   196,166       228,895


                  Gross Block                89,597   105,587    119,679   127,658   142,658       157,658
                  Less: Accum. Depn.         27,909    32,867     38,255    44,208    51,483        59,524
                  Net Fixed Assets           61,688    72,719     81,424    83,451    91,175        98,135
                  Capital WIP                11,268    12,141     10,090    13,334    10,000        10,000
                  Investments                29,346    28,378     57,269    55,547    67,018        91,158


                  Curr. Assets, L&A         70,193     81,597     81,279   101,840   109,333       123,813
                  Inventory                 40,505     45,997     45,491    52,675    62,775        71,541
                  Account Receivables        7,369      6,687      8,581     9,076    11,668        13,491
                  Cash and Bank Balance      5,703     10,310     11,263    22,432    13,249        14,834
                  Others                    16,616     18,603     15,945    17,656    21,640        23,947
                  Curr. Liab. and Prov.     44,323     47,036     80,491    85,628    81,361        94,210
                  Account Payables          27,397     29,237     34,449    43,821    47,807        54,656
                  Other Liabilities          3,736      3,833      7,859     7,371     6,554         7,595
                  Provisions                13,190     13,966     38,183    34,436    27,000        31,960
                  Net Current Assets        25,870     34,561        788    16,212    27,972        29,602
                  Application of Funds     128,172    147,798    149,571   168,543   196,166       228,895
                  E: MOSL Estimates




12 January 2012                                                                                           11
                                                                                                       ITC



                  Financials and Valuation

                  Ratios
                  Y/E March                   2008      2009      2010      2011     2012E         2013E
                  Basic (INR)
                  EPS                           8.3       8.6      10.1       6.4       7.8           9.2
                  Cash EPS                      9.4      10.1      11.7       7.3       8.7          10.2
                  BV/Share                     16.0      18.2      18.4      20.6      24.3          28.6
                  DPS                           3.5       3.7      10.0       4.5       3.5           4.1
                  Payout %                     49.5      49.9     115.1      80.2      52.7          52.7


                  Valuation (x)
                  P/E                                                        31.7      26.4          22.3
                  Cash P/E                                                   28.0      23.5          20.0
                  EV/Sales                                                    7.1       6.0           5.1
                  EV/EBITDA                                                  20.1      16.7          14.0
                  P/BV                                                        9.9       8.4           7.1
                  Dividend Yield (%)                                          2.2       1.7           2.0


                  Return Ratios (%)
                  RoE                          27.7      25.3      27.8      33.2      34.5          34.7
                  RoCE                         35.3      32.8      38.5      42.9      45.3          45.8


                  Working Capital Ratios
                  Debtor (Days)                  18        16        15        15        15            16
                  Asset Turnover (x)            1.1       1.1       1.2       1.3       1.3           1.3


                  Leverage Ratio
                  Debt/Equity (x)               0.0       0.0       0.0       0.0       0.0           0.0

                  Cash Flow Statement                                                         (INR Million)
                  Y/E March                    2008     2009      2010      2011     2012E         2013E
                  OP/(loss) before Tax       45,717   48,257    60,153    72,682    88,103       103,830
                  Int./Div. Received          3,764    3,403     3,756     5,182      6,183         7,189
                  Depreciation and Amort.     4,385    5,494     6,087     6,560      7,276         8,041
                  Interest Paid                 251      376       820       679        750           750
                  Direct Taxes Paid          14,517   15,622    21,480    22,812    28,105        32,810
                  Incr in WC                  3,413    2,648    -6,956     1,827    32,416        24,185
                  Diff in dep                   371      535       700       607          0             0
                  CF from Operations         29,030   32,990    49,481    50,707    29,425        48,436


                  Extraordinary Items             0         0         0        0          1             2
                  Incr Decr in FA            20,861    16,862    12,041   11,224     11,666        15,000
                  Pur of Investments         -1,332      -968    28,891   -1,722     11,472        24,140
                  CF from Invest.           -19,529   -15,894   -40,933   -9,502    -23,137       -39,138


                  Issue of shares               446       448    7,207      5,220         0             0
                  Incr in Debt                 -369      -698      -85          0         0             0
                  Interest Income             3,764     3,403    3,756      5,182     6,183         7,189
                  Interest Paid                 251       376      820        679       750           750
                  Dividend Paid              11,663    13,190   13,965     38,182    34,435        26,999
                  Others                     -4,729    -2,075   -3,688     -1,576    13,530        12,846
                  CF from Fin. Activity     -12,801   -12,489   -7,596    -30,035   -15,472        -7,714


                  Incr of Cash               -3,300    4,607       953    11,170    -9,183          1,584
                  Add: Opening Balance        9,002    5,703    10,310    11,263    22,432         13,249
                  Closing Balance             5,702   10,310    11,263    22,433    13,249         14,833
                  E: MOSL Estimates


12 January 2012                                                                                         12
Motilal Oswal Company Gallery
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Statement in this document. This should, however, not be treated as endorsement of the views expressed in the report.


        Disclosure of Interest Statement                                                                       ITC
        1. Analyst ownership of the stock                                                                       No
        2. Group/Directors ownership of the stock                                                               No
        3. Broking relationship with company covered                                                            No
        4. Investment Banking relationship with company covered                                                 No


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