ITC’s FCF as a percentage of net profit has increased to 86% in FY16 vs. 50% in FY14. However, this is the peak, as capex picks up and working capital normalises in future. ITC seems to be pricing in 10-12% FCF growth for the next 20 years, making the stock reasonably priced.
Our annual report analysis shows segmental ROCE is healthy for all segments except FMCG and hotels. We maintain add rating with price target R270. Our DCF shows that ITC is pricing in low double-digit FCF growth for the next 20 years, which in our view is fair given the current taxation regime and regulatory risks.
FCF conversion at 86% currently seems to be the peak and it could trend down to 75- 80% as working capital normalises and capex picks up, which too is better than the ten-year average of 50% over FY05-14
In future, ITC is likely to allocate ~50% of capex to FMCG, 15% to cigarettes, 15-20% each to paperboards and hotels, and 5% to the agri business. However, total capex could increase to R25 billion or more.
With bulk of investments allocated to the FMCG business, ITC seeks to de-risk its business in the long run.
Maintain add rating with a target price of R270. We believe that FMCG capex will increase as ITC builds other legs of growth such as dairy, coffee, and foods. We believe that in future FMCG will account for 50% of capex, cigarettes for 15%, hotels and paperboards for 15-20% each, and the agri business for 85%.
