ITC shares: Will near-term headwinds hit valuations? Target price, 2 things to watch

Emkay Global in its latest note said while the near-term business pressures like cigarette margin stress, demand in paper business and margin weakness, and the slowdown in agri business made it downgrade ITC to 'ADD' recently, it now sees additional pressure from the surge in competition and expectations of higher tax hike in the Union Budget -- to fund populist
measures. 

Emkay said its ground checks suggest steady inflation in leaf tobacco prices. Last year, amid the floods in Karnataka (crop failure in Mysore), Indian leaf tobacco prices saw inflation of 20 percent. Given the global supply issues, leaf tobacco prices have seen further inflation this year. 

"In India, we have leaf tobacco supplies from Andhra Pradesh (Mar-Jul supplies) and Karnataka (Dec-Apr supplies). Given that it’s a controlled commodity, hedging is not possible, and as such, ITC had to stock for leaf tobacco inventory (a key reason for the surge in inventory days from 59 days as of Mar-23 to 71 days as of Mar-24), in our view," it noted.

Emkay sees 100 basis points margin impact from inflation, which would partially be absorbed in mix thrust (premium continues to do well) and cost efficiency. Ideally, this kind of inflation should be passed on to consumers, but historical precedence does not suggest so, Emkay said.

"In this setting, a tax hike under the new government would be key, where a pass-through of tax and inflation in leaf tobacco would be tough, given the volume pressures. With a focus on volume, we have built the case for a 7 per cent tax hike and a 3 per cent price hike for FY25E. We see EBIT margin contracting 60bpsin FY25," it said.

Emkay said he only positive it sees in the inflationary setting is the enhanced competitive position of ITC. Additionally, ITC is looking to improve its last mile execution, which was indirect earlier. This move is likely to reflect on better realization but has a marginal bearing on the reported margin, Emkay said.

"The upcoming Union Budget under the new government and surge in competition from the single brand are key near-term watch outs. Hotels demerger is likely to conclude in Q3FY25, after all approvals. With steady macro and cyclical pressure bottoming out in FY25, we remain positive on ITC over the medium term. But given the near-term stress, we maintain ADD with Mar-25E SoTP-based target price of Rs 460 per share," Emkay said.