ITC– perennial battleground of value and other investors

Updated: Feb 15


Company NameITC Limited (ITC)


Current Share Price – INR 222 (January 11, 2022)


Market Cap – INR 273,501 cr


 

Good meme - yes/no .. whatever! we had to try..

[Disclosure - only for jokes with no intention to hurt anyone]


1. What is interesting about the stock?

Everyone knows ITC. The most meme’d stock of 2021, every investor has come across some joke or the other on the Company’s price movement and its range-bound behavior. Yet it continues to be one of the most widely held stocks in the country. I should know. My father-in-law funded our marriage by selling a small portion of it a few years ago. Have heard such stories from holders of Reliance Industries, Wipro and Hero Honda too, all senior members of the main indices of the country. So you know the storied history of the Company. In fact, a common joke I heard in pre-GST days was that the biggest Sales Tax office of the country was at Virginia House (ITC headquarters in Kolkata). This stock has high institutional holding with nearly ~55% held by them. Even LIC (16%) continues to be a large shareholder of the Company. Largest life Insurer holding stock of biggest cigarette company!


An empire built on cigarettes, expanded to enter multiple businesses like hotels, paper, lifestyle businesses, FMCG, and IT over the years. However, there continues to be a big dependence on the cigarettes business to generate profits (~80% EBIT), and in the times of ESG activism at the large funds’ level, there is pressure on the stock. The Covid-19 lockdown was good for the Company as people stocked up on ITC’s FMCG products, subsequent commodity price rise has eaten away the margins from the business.


Company is one of the few big listed conglomerates. Reliance Industries is another one Reliance Industries had gone through one cycle of demerger in 2005, triggered by succession issues but has built itself as a conglomerate again. Coming back to ITC, Company has become a conglomerate due to excess capital generation of the cigarettes business which the management has been reluctant to dividend out. As a parallel, US used to have a lot of conglomerates in 1960s driven by cost of capital and regulatory reasons but the capital market (including private equity buyouts) and anti-trust issues have forced most of them to predominantly become monoline. What would be a trigger for ITC for demerger or value unlocking – it a dream opportunity for any buyout firm to deploy large capital in one transaction and sum of parts valuation (with exit of underperforming businesses like Hotels) expected to be significantly higher than current market cap. Alas – who will bell the cat!


Business segments of the Company are (% of revenue in FY21):

  • Cigarettes (38%) – 80% market share in India; cash cow

  • FMCG (30%) - ROCE of the business has been steadily increasing to 11% in FY21

  • Agri business (16%) - ROCE of 25-30%

  • Paper and packaging (9%) – ROCE of ~20%

  • Hotels (1%) – sub 5% revenue contribution even before COVID 19; very low ROCE

What are the strengths?

  • Biggest cigarette and second largest FMCG company in India

  • Large Indian conglomerate with strong brands in FMCG, hotels, paper and lifestyle businesses

  • 200+ manufacturing facilities and 6.6 million retail selling points across various trade channels in India

  • Possibility of margin expansion in the agri-business as share of processed foods increases

What are the weaknesses?

  • Company has large FII shareholder base – ESG issues will become or is already becoming a drag

  • No promoter – Diverse set of shareholders with no alignment (LIC owns 16%; British American Tobacco owns 24%)

  • Conglomerate curse as management will be reluctant to de-merge without any pressure from shareholders (any activist shareholder around?)

  • Capital allocation issues esp. in Hotels business – most of the hotel companies operate at a very low ROCE

2. Key Historical Financials

  • Company has had muted growth over the last 5 years – 5% CAGR in revenue and 7% in profit

  • Attractive ROE and ROCE of 20-30%

  • Balance sheet is quite healthy with around INR 30,000 cr of cash or cash equivalent

3. What is my view on company valuation?


The Company has given almost zero return in the last 5 years even as peers saw big gains in their market capitalization. The Company had put a moratorium on capex, which has now been lifted, and the Company is likely to invest nearly USD 2 billion in the next 3-4 years. This is likely to result in a faster rate of growth than the ~5% CAGR in the last 5 years.


The Company has also actively been rightsizing its brand portfolio, getting rid of brands like John Players, Wills Lifestyle and Superia shampoo that were not performing, and instead building up adjacencies on fast-growing acquired brands like Savlon, Nimyle and Sunrise.


There is no significant negative impact in the cigarette volumes over the years and any rationalization of the duty structure can significantly increase the legal business at the cost of imported illicit and contraband cigarettes. If that were to happen, the Company could see significant growth rates.


The Company is currently trading at P/E TTM multiple of ~19x, which is quite low for a Company with a significant FMCG portfolio. With a dividend yield of nearly 2.5% on average except in FY21 (dividend yield of 4.9%), the Company is a good buy at dips if you hope that value unlocking may happen one day. That day it will given bumper returns to Its shareholders. Woh din kab aayega!


4. What are the risks to the investment analysis?


Risks to the analysis are:

  • Company is Board-run and hence, accountability and leadership can get compromised if the Board members do not have adequate tenure

  • Stock has not performed for nearly 5 years and in case of stock price rise, there might be selling coming from old shareholders especially FII, that might limit the upside of the stock

  • Any increase in duties could further impact the sale of legal cigarettes impacting the main profit center of the Company

 

About the Author


I have over 16 years of experience in private equity and public markets. I am an engineer by background and MBA from a premier institute in India.


Disclosure


I have no stock, option or similar derivative position in any of the companies mentioned since last 30 days, and shall not initiate any such positions within the next 5 days. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from SocInvest). I have no business relationship with any company whose stock is mentioned in this article.


I am not a SEBI registered advisor. This article is purely for educational purpose and not to be construed as an investment advice. Please consult your financial advisor before acting on it.


I have used publicly available information while writing this article.


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