Expect ITC to do well in Q3 with almost 17% EBITDA growth: Abneesh Roy

“In Q3, we will not see rural recovery being highlighted by any of the companies in any meaningful manner. Yes, because of the base effect, we will see that the numbers are looking a bit better but still I do not think there is rural growth for the sector. There will be companies which are gaining market share,” says Abneesh Roy, Executive Director-Institutional Equities, Nuvama Group

A lot of companies have declared their numbers in terms of the sort of growth they expect, margins or their outlook. What do you make of a lot of these companies declaring their volume growth and their path of margins?
We have seen quarterly sales updates coming out with three-four companies. There are four-five key things. One, there is a margin improvement for most companies quarter on quarter but the YoY pressure for most companies is still there. My sense is that in Q4, further margin recovery will happen because of the current crude oil prices and other deflation. There is always a lag of two to three months. So, in Q4, further build up in margins will happen.

In terms of demand, rural demand still remains quite challenging although on a base effect, the numbers will look a bit better but still the rural FMCG volumes are declining 4-5%. It used to decline 8% to 9% but for the sector, urban growth is much better. So e-commerce, quick-commerce are clearly helping.

Also we see that now because of a deflation in categories like noodles, biscuits, etc, and even soaps, the volume growth has accelerated from Q4 because of the promotions. So, overall, we are positive on the sector. Our top picks will be Hindustan Unilever, Britannia, Godrej Consumer and Nestle. Definitely things are improving but yes, in Q4, the real margin improvement will happen.

I specifically wanted to speak about ITC. You put out an interesting note talking about how in this Budget, there is a possibility of increase in the cigarette tax. Could you detail that out for us? What kind of impact will it have and why do you expect this to happen in the first place?
We have ITC as a buy and we have a target price of Rs 400. We upgraded the ITC stock in February last year post the Budget and after that, the stock has been one of the best performing stocks in Nifty and even in the consumption space.

Even in Q3, we expect ITC to do well. We expect almost 17% EBITDA growth. It will be in the top tier in terms of growth. We also expect margin expansion YoY for ITC which is a very rare thing currently.

Apart from this, we also like the fact that the company has been doing strategic M&A. Coming to your question, this is a key thing which is monitorable every year. Having said that, if you analyse the data, it is best if the government is rational in terms of tax hike. Cigarettes is hardly 8% of the total tobacco consumption but in terms of the tax collection, it is almost 75-80%.

Plus, the illegal cigarette industry is almost one-fourth of the industry. So whenever rational taxes are there, the legal industry does better and they retake market share and that is good for the government also. It is good from an overall economic perspective also. So if at all there is some hike, we need to see whether that hike happens or not. It is a zero-one event and it is difficult to say whether in an inflationary environment, if the government will go for a tax hike; but if they do, it should be either a no hike or a mid-single digit hike because anything beyond that will have a cascading effect on the taxation. In cigarettes also, there is a cascading effect.

Second, bidis and the other forms of tobacco consumption are taxed in a very limited manner. Although they account for 92% of the total tobacco consumption in India, in terms of taxes, account for hardly 20%. I would say that it has to be a rational tax hike if at all, but it is very difficult to say whether tax hike will actually happen or not.

In terms of the sector and the sort of move we are seeing, is it difficult to say now that the markets are trying to price in a rural recovery or waiting for comments on rural recovery from various management?
In Q3, we will not see rural recovery being highlighted by any of the companies in any meaningful manner. Yes, because of the base effect, we will see that the numbers are looking a bit better but still I do not think there is rural growth for the sector. There will be companies which are gaining market share.

From Q4, the base benefit will be there but I would expect real rural recovery to start only from FY24 because by that time, maybe more deflation in fertilisers, diesel prices and general inflation in the life of the farmer will happen.

The key important thing is around 30% of the population is facing tough times from a monsoon perspective. UP, Bihar, Jharkhand, West Bengal had a 20-30% deficit rainfall this monsoon which got over a few months back and that is definitely impacting.

I would say next year, if the monsoon is good and the deflation is there for the farmer, then we can definitely hope. Also, this is an election year and maybe there will be some benefit in terms of the stimulus programmes but nowadays, every year there is a stimulus for the rural. I will not say that because of the election year, there is going to be a big uptick in terms of stimulus but there can be some ruboff effect in terms of sentiments for rural India because of elections in nine states and general elections.

What is your take on the paint sector as well? There is a lot of capex happening there, a lot of heated competition but stocks like Asian Paints etc have not done much in the last 12-18 months. What is your take on the paint sector and which stocks are likely to outperform there?
We are positive on Asian Paints. Asian Paints is a high beta stock. The quarterly results are a key monitorable. In Q3, October was very tough for the industry because of very high rainfall close to the festive season. Normally, the painting happens in the festival season and there is a gap of at least two to three weeks between rainfall and the festival. This year, it was just a gap of 8-10 days.

In November and December we have seen very good recovery for the paint demand and I would expect that even next year the paint demand for at least Asian Paints should be one of the highest in the total consumption space.

When I compare FMCG versus paint companies, I think paint should grow faster even next year because there is waterproofing, putty and construction chemicals, which helps core paints. On the capex bit, it is reflective of the four to five year gestations. The Madhya Pradesh project for Asian Paints will take four to five years for the first phase. That is a very long time and there is growth in the industry. I would say that Asian Paints is a good stock to own. Definitely in Q3 and Q4, we will see margin expansion because crude and titanium dioxide has corrected but the Q3 demand will be weak for the entire sector and in Q4, we should see recovery.