Investor's Eye: Infosys (Downgraded to Hold), ITC (Excise duty hike of about 20% to dent cigarette volumes)

 

Investor's Eye [July 11, 2014]  Sharekhan www.sharekhan.com

Summary of Contents   STOCK UPDATE     Infosys Recommendation: Hold Price target: Rs3,550 Current market price: Rs3,326   Downgraded to Hold   Key points  For Q1FY2015, the revenues of Infosys in reported currency grew by 2% QoQ to $2,133 million (up 1.5% QoQ on constant-currency basis, volume up by a decent 2.9% QoQ). The EBIT margin declined only marginally by 34BPS QoQ to 25.1% attributed to lower depreciation (a change in the depreciation policy contributed 110BPS to the margin) and higher utilisation at 80% which together negated the margin head winds from wage hikes and the rupee's appreciation. Without considering the positive tail winds from depreciation, the EBIT margin still beat the estimate. The net profit for the quarter declined by 3.5% QoQ to Rs2,886 crore.  During the quarter Infosys signed five large deals with TCV of $700 million. The cumulative TCV of deals signed in the last four quarter stood at $2.3 billion. The company has maintained its guidance for FY2015 at 7-9% (implying an ask rate of 3.6% QoQ to achieve the upper end of the guidance). The management commentary remained optimistic on an improving demand environment, though mixed signs were visible in some of the discretionary projects.  Valuation: In the last three years, Infosys has given a false start and raised hope of a sustainable growth turn-around in several quarters. However, given the volatility in the performance, we would prefer to wait for a few more quarters for an improvement in the revenue growth (which still lags peers') which is vital for multiple re-rating (Infosys is trading at a 28% discount to TCS). The joining of Vishal Sikka (as the new CEO) on August 1, 2014 and his roadmap for a business turnaround would be keenly watched by investors. Given the recent run-up in the stock (close to 12% rise in less a month) and lack of any re-rating support from the earnings performance, we downgrade the stock to Hold from Buy with a price target of Rs3,550.      ITC Recommendation: Buy Price target: Rs369 Current market price: Rs346   Excise duty hike of about 20% to dent cigarette volumes   Key points  In union budget 2014-15, the government increased the excise duty on cigarettes by 11-72% in bid to curb cigarette consumption in the domestic market. For ITC the weighted average excise duty hike for FY2015 on cigarettes stands at 21%, which is higher than our expectation of a 10% hike.  ITC has to take price increase of about 20% in its cigarette portfolio to mitigate the impact of the steep excise duty hike in budget. It had increased the prices of selected brands before the budget and the cumulative price increase currently stands at 9-10% (thus, it would require a price increase of another 10%). Another round of price increase would definitely add pressure on the sales volume of cigarettes in the coming quarters (especially in the 64mm segment, where we expect prices to go up by 50-75 paise per stick). We expect the cigarette sales volume to decline by 3.5-4.0% in FY2015. However, the price increases would help the cigarette business' PBIT margin to stand at 34% in FY2015. Though we have downgraded the earnings estimate by 2.5%, but ITC is well poised to achieve a CAGR of about 16% in earnings over the next two years which is much better compared with some of the other large FMCG stocks. ITC is currently trading at 27x its FY2015E earnings (at a 22% discount to HUL's valuation). We had strongly recommended buying the stock at Rs314 levels, given the panic selling on June 23, 2014. We maintain our Buy recommendation on the stock with an unchanged price target of Rs369 (we will review the price target post-Q1FY2015 results). Key risk to earning estimates: Any significant increase in the value-added tax rates in some of the key state budgets remains a key risk to the earnings estimate. Click here to read report: Investor's Eye   Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a position in the companies mentioned in the article.

Regards,  The Sharekhan Research Team

 

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