ITC Limited will be announcing their fiscal 2014 results on May 23, 2014. Morningstar equity analyst Suruchi Jain expects earnings to grow by 17%, aided by strong top-line growth of 14% and expansion of operating margins by 90 basis points to 33.5%.
Over the last 5 years, the company has expanded its operating margins, or earnings before interest and tax, by 550 basis points, to 32.6% in 2013, from a low of 27.1% in 2009. This was primarily on the back of margin expansion in its cigarettes segment (56.2% of 2013 sales) and its consumer products division (14.6% of 2013 sales) reaching closer to breakeven.
This year, we anticipate cigarette margins should expand by 200 basis points to 34% as more revenue flows to the bottom line with low-tax-incidence cigarettes gaining traction in the market, and consumer products division should reach breakeven with 0.8% in operating margins.
Historically, top-line growth was aided by strong growth in its consumer products and agricultural businesses, as well as price increases in ITC’s cigarette portfolio--to pass on rising excise taxes to consumers. In our opinion, this pricing power especially in its core category of branded cigarettes, where it holds majority market share in India, represents the strong competitive advantage of the company’s addictive smoking products. As a result, we keep our narrow economic moat, and stable moat trend rating on the stock unchanged.
Overall, the firm continues to generate returns on invested capital, or ROICs, several notches above its estimated cost of capital of 11.3%, and pays out dividends equal to 60% of its net income to shareholders each year. While we anticipate dividend payout in 2014 to remain at the historic 60% levels; the stock now trades close to our fair value estimate and we believe new investors should wait for an adequate margin of safety before investing in this cigarette major.
To read Suruchi's investment thesis and analysis of ITC Limited, click here.