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Spark Capital: Initiating coverage on FMCG Large Caps – Expect ITC to outperform Hindustan Unilever




Spark Capital Advisors(India) Private Limited


20 Jan 2013





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Initiating coverage on FMCG Large Caps – Expect ITC to outperform Hindustan Unilever We initiate coverage on FMCG large caps ITC and Hindustan Unilever (HUL) through this note. We are positive on both these stocks, however believe that ITC should significantly outperform HUL over 12-15 month horizon. Our opinion is a combination of the following fundamental and valuation arguments. 1) ITC’s pricing power in cigarettes gives a substantially high comfort on the company delivering a 20% yoy earnings growth over the next 2 years. While we expect ~9% volume growth and 17% EBITDA growth CAGR for HUL over the same period, risk in delivering on both these expectations is high primarily due to a high base and threat of slowdown in discretionary spending. 2) Increase in effective tax rate from ~25% to ~30% from FY13-FY15E for HUL would limit earnings growth CAGR to ~13% (EBITDA growth of 17%) against ~21% for ITC. 3) In perspective of the above fundamentals we find ITC trading at 23.8x/ 19.6x of FY14/ FY15E earnings offering significantly higher upside of ~23% by Mar’14 (SOTP based) compared to HUL trading at 28.4x/ 25.6x earnings and offering a potential upside of ~13% (29x FY15E EPS) over the same period. At our target prices HUL and ITC would equate on FY15E FCF yield. 4) We initiate coverage on ITC and HUL with a Buy and Add rating respectively and firmly believe that the former should outperform the later in stock price performance. Summary of Thoughts on stocks Hindustan Unilever: We like HUL’s aggressive approach on both the product and distribution aspects over the past two yrs and expect ahead of market efforts to help sustain volume growth momentum in high single digits. Further, we expect favourable raw material prices (especially palm oil - down 27% yoy in 3QFY13) to help better/ sustain the recovery of profit margins in the soaps and detergents segment and drive better gross margins for the company. We see the high growth potential, high margin category of Personal care to be the key driver of growth and profitability for HUL over medium-long term. ITC: We are appreciative of ITC’s strong pricing power in cigarettes that shall continue to ensure ~20% earnings growth. With hefty increase in excise duty on cigarettes in the last Union budget we see high probability of low increase in FY14. This would mean a low price increase in cigarettes and enable better volume growth. Also the FMCG business (non cigarette) is moving towards profitability with good sales momentum. With much better comfort on a higher earnings growth compared to HUL and comparatively better valuation comfort we prefer ITC over HUL.

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