December 8, 2023

In the volatile world of stock markets, things don’t always go as expected. A case in point is the recent performance of two behemoths in the Indian corporate sector: ITC and Hindustan Unilever (HUL). Both companies released their Q2 results, but despite ITC’s robust figures, its shares dipped more than HUL’s. Let’s dissect the numbers and try to understand what’s happening.

ITC’s Q2 Figures

In the first half of trading following the Q2 results, ITC’s shares saw a decline of 2.4 percent. However, when you look at ITC’s performance in the FMCG sector, the numbers are impressive. Their FMCG sales soared by 8.3 percent, which is double the rate at which HUL’s did. Furthermore, the flagship business of ITC, cigarettes, witnessed a sales growth of 10.1 percent. Net profit also grew by 10.3 percent, surpassing HUL’s 4 percent.

The Puzzle: Why the Decline?

So, the puzzle remains: why the decline in ITC’s shares? Expectations may have been set unrealistically high, which could explain part of the decrease. But when examining ITC’s results more closely, some grey areas become apparent.

ITC expressed uncertainty about the consumption demand outlook and highlighted a few products, such as atta, soaps, spices, and agarbatti, as key drivers of growth. This suggests that others like snacks, biscuits, shampoos, and household care might not have performed as expected. Additionally, ITC mentioned that commodity deflation led to aggressive competition from local and regional brands.

Although ITC’s hotels business performed well, the paper and paperboards segment saw a 50 percent drop in segment profit due to adverse business trends. The outlook for its agricultural trading business has dimmed due to government restrictions on key exports like wheat and rice. Despite these challenges, ITC managed decent profit growth, even though its EBITDA margin remained flat compared to the previous year and declined sequentially.

Cigarettes, the Key Determinant

The central conundrum lies in ITC’s cigarettes business. The company did not seem to accelerate its efforts to boost growth and profitability in this segment. In fact, cigarette segment margins decreased by 2 percentage points compared to the previous year, remaining flat sequentially. There was also a moderation in cigarette sales volume growth, estimated at 4 percent compared to the 8 percent growth seen in the June quarter, as reported by Jefferies Research.

ITC cited cost escalation in tobacco and other inputs leading to price increases. The flattening of margins hints at the impact of inflation on its product mix. The cigarettes business remains a cornerstone of ITC, contributing a solid 80 percent of its segment profits, making it the most crucial determinant of earnings growth.

The Fear of Stagnation

If the moderation in volume growth continues and cigarette segment margins remain stagnant, it could become a headwind for earnings growth. A potential turnaround in the paperboard business or the FMCG sector could offer support, but this is unlikely to happen in the short term, especially if HUL’s commentary serves as an indicator.

The fear of enduring middling margins and growth prospects might explain why ITC’s shares fell as much or even more than HUL’s, despite being comparatively undervalued. ITC trades at 29 times its trailing earnings compared to HUL’s 59 times.

The stock market can be unpredictable, and even strong fundamentals don’t always translate into rising share prices. Investors should keep a close watch on these two FMCG giants as they navigate the changing tides of the market and consumer demand.

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