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ITC’s cigarette business delivers again

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ITC Ltd led a handful of shares in the Sensex basket that bucked a decline on Thursday. The cigarette major’s share rose by 2.6% on a day when the Sensex fell 1.2%, as investors warmed up to its June quarter earnings.

In 2010-11, the company’s volume growth had been affected by a sharp hike in prices to compensate for higher excise levies. But the Union Budget 2011 was kind enough to spare cigarettes from any further excise hikes. Investors were hopeful this could lead to better volume surge, with price hikes providing further impetus to growth.

In the June quarter, cigarette sales have risen by about 16% year-on-year (y-o-y), better than the 13% growth seen in the March quarter. The cigarette segment’s profit has risen by about 21% compared with about 18% in the previous quarter. That is a good sign, as this segment contributes only 40% to sales, but accounts for about 80% of profit before interest and tax.

If the cigarette segment is revving up for a good year, ITC’s other businesses are not doing badly either. Its packaged consumer goods business’ sales rose by about 20% y-o-y, while losses fell by about 14%. ITC’s main focus in this business is still on growing scale, and while a few businesses may be making profits, the pace of new product introductions and the focus on scaling up and expanding reach will keep margins under pressure. It has said that it is investing in manufacturing and distribution in its foods business.

Revenue of the hotels business rose by just 10% y-o-y, but profit growth was a robust 33%, and it appears the focus was more on profitability than on revenue growth during this quarter. Paper was a star performer, with sales and profit both rising by about 20% each.

ITC’s financials reveal that material costs are rising sharply, up by about 28%, or 8 percentage points more than the revenue growth. This could be attributable to its consumer business, where competition and inflation are playing havoc with margins. Operating profit margins were down by 10 basis points y-o-y.

While its operating profit rose by 20%, a sharp jump in other income saw net profit rise by about 25%. ITC’s results are good, but its flat operating profit margins are a concern and need monitoring over the next few quarters. While its cigarette business is in fine form, its growing consumer business could pull down margins.

Still, the company’s main business of cigarettes is under little threat from rising interest rates, or even slowing economic growth. At a time when interest rates threaten to spook investors, ITC could be among the stocks that may outperform.

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