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Multi growth drivers: ITC is moving in the right direction by de-risking its business model and entering new areas. The company has successfully invested strong cash flows from its cigarette business into growth businesses such as hotels, food s and rural retailing. Strong cash flows (around Rs.20 bn) had enabled ITC to establish a dominant position in the hotel and paper business. It has also successfully executed its various businesses to ensure that the firms ROE stays at a healthy 25%. On back of these parameters we estimate a 20% CAGR growth in earnings over the next 3 years.
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Near monopoly in cigarettes: Despite campaigns against smoking and punitive tax rates, ITC has managed to grow its core cigarette business at a CAGR of 9.9% during the period FY02 to FY07. ITC's profits from cigarettes tend to grow even in an adverse tax environment (9% YoY growth in 1QFY08 despite tax hikes). Net price realisations (net of all taxes) tend to outpace volume falls in a declining market, resulting in growth in net sales. In the 2007 budget, the excise duty on cigarettes was further hiked by 5%. Also, a 12.5% VAT by states governments has become applicable. ITC has passed on the increase in taxes by a ~20% effective hike in prices. This proves ITC's strong positioning in cigarettes in the domestic market, where it has a share of 72%. We believe ITC's dominance is unlikely to diminish in the medium term as it has the best brand recognition, distribution and portfolio of products across price points.
Cigarette business continues to remain the mainstay of ITC, accounting for 66% of FY07 revenues. The company is looking at upgrading its cigarette units to beat competition from imports and contrabands.
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Currently, out of the total amount of tobacco produced in the country, around 48% is in the form of chewing tobacco, 37% as bidis and only 15% as cigarettes. In the rest of the world, production of cigarettes is 90% of total production of tobacco related products. Although the market is huge in absolute numbers, per capita consumption of cigarettes in India stands at approximately 1/10th the world average and this underlines the vast hidden potential. As disposable income increases, people might shift from bidis to cigarettes. Being the leading player in the segment, ITC is likely to be a big beneficiary of this change. We have factored in a modest 8% compounded rate of growth in revenues for the cigarette division for the next three years. It should be remembered that the same has grown at a CAGR of 10% between FY02 and FY07.
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Hotels: ITC is the second largest player in the hospitality industry in India, only trailing Indian Hotels (The Taj Group). This division continues to benefit from capacity expansion as well as the upturn in occupancy rates. This division displayed a staggering topline CAGR of 43% between FY02 and FY07. To strengthen its position and to ride the boom in hotels in India, the company consolidated operations by merging subsidiaries ITC Hotels and Ansal Hotels with itself during FY05. The company is likely to invest around Rs10 bn in the Bangalore, Chennai and Hyderabad hotels in the next 3 to 4 years. It is also constructing a resort at its golf course at Gurgaon and is looking for land in the city to set up a hotel. It also plans to set up a mid-sized three-star hotel in Chandigarh and two or three properties in state capitals and metropolises. The vision of the management is to have a hotel in every state capital. With 75 hotels (5,500 rooms) under the chain, ITC is expecting to add another 27 properties (3,000 rooms) under its management in the coming years. Recently, it had tied up with Starwood Hotels & Resorts to bring the latter's premium brand, the Luxury Collection to India.
According to recent estimates of the WTTC (World Travel and Tourism Council), Indian tourism demand will grow at 8.8% CAGR over the next nine years (2006-15), which would place India as the second most rapidly growing tourism market in the world. However, addition to the room inventory over the next 2-3 years is not expected to be commensurate with the growth in demand. As per industry estimates, India will require around 120,000 hotel rooms over the next 3 years. Overall, the increased business and leisure related travel, strong room demand, and higher occupancies would help the players in the sector to sustain their pricing power.
Paperboard - Expansion benefits: ITC is the leader in the domestic paperboards market having a share of 30% in value terms. It is also the only player in the premium value added paperboard segment. It has a market share of 77% in Cigarette Tissue segment, The paper segment provides synergies to its business as more than one-third of its paper production is used for internal consumption. This division has grown at a CAGR of 14% during the period between FY02 and FY07.
The paper industry is capital intensive and prone to global cycles. The capital intensity of the business is bound to increase as environmental norms tighten. Although the overall paper and paperboard industry in India is growing at around 7%, the value-added paperboard segment continues to grow at a substantially faster pace of around 20%. ITC is making investments in the paper business to capitalize on trends in the industry. Over the next 2 to 3 years, the company plans to invest Rs 10 bn to expand its capacities. It is also in the process of doubling pulp capacity to 200,000 tonnes per annum, which would help it reduce dependence on the global pulp cycle and cut costly imports. We expect the paperboard segment to grow at a CAGR of 14% over the next three years, in line with its historical growth rates.
| Paper: Capacity addition |
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| (TPA) | FY07 | FY09E |
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| Coated and uncoated boards | 320,000 | 400,000 |
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| Paper | 30,000 | 30,000 |
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| Specialty paper | 24,000 | 125,000 |
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| Total paper | 54,000 | 155,000 |
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| Pulp | 100,000 | 200,000 |
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Non-cigarette FMCG: ITC has very cleverly used its distribution and procurement network to build its new consumer (FMCG) businesses.
| FMCG businesses |
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| Category | Mkt size (Rs m) | ITC share (%) |
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| Biscuits | 50,000 | 9% |
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| Match sticks | 12,000 | 10% |
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| Branded atta | 12,000 | 52% |
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| Ready to eat | 800 | 24% |
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| Confectionery | 20,000 | 20% |
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Since the launch of its ready-to-eat Kitchens of India brand in 2001, ITC has established itself in key FMCG segments like atta, ready-to-eat meals and biscuits through its Aashirvaad, Kitchens of India and Sunfeast brands respectively. The company is now looking to expand into new product categories. It is using its established procurement network to source wheat and other agri inputs at a price lower than the competition, also ensuring high quality control as a result of direct control over procurement. In four years, the company's turnover has touched Rs 17 bn from Rs 1 bn in FY03 in this segment
Let us have a look at the company's future plans and prospects of each of the divisions in the non-cigarette FMCG segment.
Foods: The product portfolio now comprises more than 100 distinct food products under five brands. In Biscuits (Sunfeast brand) ITC has seen robust growth and has captured a 9% market share of the Rs 46 bn biscuits sector. The company is constantly introducing innovations and variants within a category. ITC has recently launched its Bingo brand in the Rs.20 bn snack market. ITC is targeting 25% market share over next 2 years. The snack food market is growing at 30% annually.
Staple Foods (wheat flour and salt) under the Ashirwad brand has been one of the key growth drivers in packaged foods. The branded atta enjoy 55 % market share of the Rs 10 bn organized market. ITC has successfully captured a market share of about 24% in the Rs 800 m ready-to-eat foods segment. It has also entered the branded spice market valued at Rs 4.5 bn and is aiming for a 20 % market share in the first year itself.
Retailing: ITC is also a strong player in lifestyle retailing and has established its brands like Wills Lifestyle and John Players. ITC is targeting a 30% plus growth in its lifestyle retailing business by expanding its stores
ITC's Expressions has emerged as the largest greeting card brand sold with 25% of the share in Rs 3 bn domestic greeting card market. It has launched stationery under the Classmate and paper Craft brands. The market size is estimated at Rs 6 bn and is growing at 10% per annum. It also controls 12% market share in Rs 10 bn matchbox market. It acquired WIMCO (through its subsidiary) to increase its market share.
Personal care: ITC is also gearing up for the launch of a mass brand in the home and personal care space. The company has already set up a separate strategic business unit (SBU) for this purpose. Given its immense distribution strength, ITC shouldn't find it hard to make a successful entry into the Rs 80 bn home and personal care segment. However, it would face tough competition from the existing players.
Though currently the segment is suffering a loss at the PBIT levels, we expect it to turn profitable in FY10. We expect the division to grow by 43% over then next three years, much lower than the 78% growth the segment achieved in the previous three years.
Agri business: ITC is one of the largest exporter of agricultural commodities and has a significant presence in soya, wheat, rice and marine products. Currently, ITC sources 13 commodities and plans to enter the fruits and vegetable markets. ITC plans to increase exports of value-added aqua-products, processed fruit and organic products. Exports of leaf tobacco, nonbasmati rice and wheat are also expected to drive exports in the coming years. It also has tied up with Japanese trading house Marubeni for food business including exports of Indian beans. Currently, it contributes 13% (post inter-segment transfers) to the total revenues and we expect it to touch to 17% going forward.
E Choupal- rural initiative: ITC's rural initiative is likely to be one of the key long-term growth drivers for the company in our view. ITC has built on its sourcing scale to establish an enabling infrastructure, called e-choupal. It also saves about 3% to 5% of the procurement costs. Started as a sourcing venture for ITC's non-cigarette FMCG business, e-Choupal is now undergoing transition to become a highly effective distribution channel and would be known as Choupal Sagar. There are over 6,400 E-choupals spread across 29,000 villages and reaching over 3 m farmers. ITC has also entered into collaboration with over 40 companies to sell seeds, pesticides, fertilizers, farm equipment, consumer product goods, finance and insurance.
The company plans to expand this initiative to 100,000 villages and reach over 10 m farmers by 2010 and source a wider range of products like spices, cotton and vegetables. It is also planning to set up new small format stores in rural areas on the lines of its existing hypermarket chain, Choupal Sagar. The company would open 140 stores (currently 3 stores) in 54 towns in the next three-four years. Though currently, it is in an investment phase, we expect by 2011, the company would generate revenues from e- choupals.
