ITC Rating at 2-Year Low as Shares Near Record: Corporate India

Analysts are the most bearish on ITC Ltd. (ITC) in two years as Asia’s second-biggest tobacco company by market value prepares to sell cheaper cigarettes, risking margins already under pressure from slowing sales at its hotels.

The consensus rating, or the average of recommendations updated by analysts in the past year, dropped to 4.28, with 5 denoting a buy and 1 a sell, according to data compiled by Bloomberg. The gauge is the lowest since October, 2010. Shares rallied to an all-time high last week on record profit, making the stock more expensive than Japan Tobacco Inc., Asia’s biggest cigarette maker by market capitalization.

The 45 percent surge in ITC this year is overdone because the maker of Gold Flake and Wills cigarettes has limited room to raise prices should the government levy higher taxes, said Krishnan Sambamoorthy, an analyst at Fortune Equity Brokers India Ltd. in Mumbai. ITC’s stock is priced 31 times its estimated earnings, the second highest among the 30 members that constitute the BSE Ltd.’s benchmark Sensitive Index (SENSEX) or Sensex. Hindustan Unilever Ltd. (HUVR), the nation’s biggest consumer company, had a ratio of 39, while Japan Tobacco was priced at 13.

“We don’t see further room for upside,” said Sambamoorthy, who advises holding the stock. “What has driven this rally is primarily the lack of investible opportunities in other sectors.”

Price to Earnings

Prime Minister Manmohan Singh’s recent push to end a policy paralysis and attract investment into the $1.8 trillion economy may boost prospects for stocks other than ITC and Hindustan Unilever, he said.

Still, 37 of the 50 analysts tracked by Bloomberg recommend buying ITC, with nine rating it a hold and four a sell. That compares with 44 advising purchasing the shares at the beginning of the year. Standard Chartered Plc (STAN) and Religare Securities Ltd. are among brokerages that have cut ITC’s rating after it announced its earnings for the quarter to Sept. 30.

ITC is adding new businesses to cut dependence on cigarettes as the government cracks down on the use of tobacco in the world’s second-most populous nation, with bans on smoking in public places and on advertisements. Cigarettes accounted for 64 percent of its revenue in the year ended March 31, down from 70 percent in 2006

India’s health ministry on Oct. 22 notified a new set of warnings to be printed on packs of tobacco products, including images of cancer-ridden mouths and lungs, to discourage consumption, effective April 1, 2013. An August ruling in Australia banned company logos from cigarette packs, spurring concerns that India may follow with such rules as well.

Shorter Sticks

The Kolkata-based company has increased cigarette prices in the past to offset taxes. It started selling sticks less than 65 millimeters in length in most markets across the country “to counter exponential growth in illegal and tax-evaded cigarettes,” spokesman Nazeeb Arif said in an e-mailed response to queries.

The measures resulted in a 14 percent jump in revenue last quarter from the tobacco products, while volume stayed unchanged, analysts including Abneesh Roy, Hemang Gandhi and Pooja Lath of Edelweiss Securities Ltd., and Sanjay Manyal of ICICIdirect wrote to investors in separate reports after the earnings announcement.

“Another hefty tax in the upcoming budget can moderate ITC’s performance, but isn’t priced in,” Sanjay Singh and Pratik Biyani, analysts at Standard Chartered wrote in a report dated Oct. 20. “Implementation of plain packaging is also a risk” though it may not happen immediately, they wrote, cutting their rating to “in-line” from “outperform.”

Beating Estimates

As a matter of policy, ITC doesn’t offer guidance or discuss pricing strategy, Arif said in his e-mail.

Net income for the maker of Bingo snacks rose 22 percent from a year ago to 18.4 billion rupees ($341 million) in the three months, ITC said Oct. 19, beating the median 17.6 billion rupee estimate in a Bloomberg survey of 24 analysts.

Shares touched a record 299.20 rupees the same day and gained 0.7 percent to 292.05 rupees in Mumbai trading today. The Sensex has gained 21 percent this year, lagging behind ITC.

The 14-day relative strength index rose to 79 on Oct. 19, above the 70 level that indicates to some traders that a decline is likely. The RSI level was 65 on Oct. 23.

Revenue from hotels as a share of total sales declined to 2.9 percent from 3.5 percent a year earlier because the “hospitality sector continued to be adversely impacted by the weak conditions prevailing in key international source markets,” ITC said in a statement on Oct. 19.

‘Remarkable’

ITC may benefit from the government crackdown on tobacco consumption as consumers move from chewable varieties to the lower-end short cigarettes, said Ruchita Maheshwari, a Mumbai- based analyst at Nirmal Bang Securities Pvt., who rates the stock a hold with a 12-month target of 317 rupees.

“ITC shows remarkable performance every quarter,” she said. “I think the company has the ability to move up from here.”

Net sales for the company rose 20 percent to 71.5 billion rupees in the three months ended Sept. 30, from 59.7 billion rupees a year earlier, ITC said in a statement to the stock exchange on Oct. 19. The so-called Ebitda margin, a gauge of the company’s profitability, averaged 33.4 percent in the five financial years through March 31.

Limited Potential

Stocks in capital goods, power and real estate industries may offer higher returns over a year than ITC because Prime Minister Singh has initiated measures to kick start Asia’s third-biggest economy after two years of political gridlock stalled legislation, said Ronald Siyoni, a Mumbai-based analyst with K.R. Choksey Shares & Securities Pvt.

Net purchases of stocks by foreign funds have jumped 41 percent to $18.1 billion since Sept. 13, when Singh raised diesel prices to cut subsidies amid protests from opposition parties, according to data compiled by Bloomberg.

“Whenever there’s a turnaround in the economy, money would get reallocated to cyclical industries, which would again show the limited upside potential for ITC,” said Siyoni. “We are not comfortable at this level because of high valuation.”

To contact the reporter on this story: Malavika Sharma in New Delhi at msharma52@bloomberg.net

To contact the editor responsible for this story: Stephanie Wong at swong139@bloomberg.net

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