The following is the recently-issued Stock Analyst Note on ITC Ltd, published by Morningstar Analyst Suruchi Jain. Registered Morningstar Members gain exclusive access to our full ITC Analyst Report (PDF), including fair value estimates, consider buying/selling prices, bull and bear breakdowns, financial and company overviews, and risk analyses. Not a Registered member? Get these reports immediately when you sign up with Morningstar for free.
ITC Limited still faces challenges following the implementation of a cigarette tax hike that's lighting a fire under illicit trade practices. Still, we still think fiscal 2013's results support our take that ITC's brand strength and pricing power remain intact, with the addictive nature of its core product underpinning its narrow economic moat rating.
Sales growth ended the year up 19.4%, slightly ahead of our forecast of 15.5%. Even so, adjusted earnings per share came in exactly in line with our INR 8.85 per-share estimate. Top-line growth was driven by sales of agricultural produce (14% of consolidated net sales, up 26.4%), other consumer products (13.7% of net sales, up 26.4%) and cigarettes (57.1% of net sales, up 16.8%).
The firm also managed to squeeze out a 70 basis-point operating margin improvement, ending the year at 32.6%, as increased cost pressures for commodities such as wood and coal were offset by savings from the firm's efficiency initiatives.
From a segment perspective, improvements in its cigarette segment drove margins 110 basis points wider, to 32%, even with the tax headwind. Its consumer products division reached closer to break-even, where operating margins were -1.3% versus -3.9% last year.
Beyond increased government intervention via rising cigarettes taxes, the firm is facing competitive pressures from cheaper substitutes, such as chewing tobacco and bidis (leaf-rolled tobacco). Despite this, ITC has defended its turf for several years by continuously investing in product innovation, and by marketing its core brands. We think this will continue to sustain its competitive advantages, and promote excess shareholder returns over the longer term.
In addition, the firm has recently expanded its product set to include lower-priced products, which are subject to a lower tax rate. This will allow it to increase its customer reach, which we view favorably.
We intend to review the assumptions underlying our discounted cash flow model, and will likely raise our fair value slightly to account for the additional cash generated since our last update. However, even with a slightly higher fair value estimate, we think these shares are fairly valued at current trading levels.