The Business of ITC and Key Takeaways From the Analysts Meet

ITC Ltd.’s shares have seen some action for the better part of a year, to say the least.

Last year, the company had attained the unenviable glory for being a laughing “stock” on social media as it got left behind in the bull rally for a considerable time. Although it caught up with the gains towards September, the company still remains a dinner table conversational punching bag amongst the investing community owing to its interesting yet peculiar ride supported by a healthy dividend payout.

Yet another dimension was added to those conversations yesterday when the company held its first-ever analysts day meeting. The speculation over the meeting’s agenda had sent the stock pricing surging by as high as 7% over the past week.

(FYI: Analysts meeting is an annual gathering held by many publicly-traded corporations in which company executives (CEO, CFO etc.) provide relevant information and forecasts about the company’s strategic outlook and financial performance.)

Let’s see what all was expected and delivered.

The ABCs of ITC

With a market cap of ₹2,78,732cr ($36.7bn), the Imperial Tobacco Company (as ITC was known at the time of its establishment in 1901) is one of the largest conglomerates in India. The tobacco-to-atta-to-hotels giant remains the biggest cigarette-maker in the country and the sixth-biggest in the world today. Its fast moving consumer goods (FMCG) segment remains fast-moving as well with a remarkable turnaround in cash flows gradually.

But that doesn’t underscore the almost decade-long painful journey experienced by the company. Increasing taxes on cigarettes (over 150% in 2010–19), headwinds in ESG (environment and social governance) on account of the tobacco business, a long-struggling FMCG business and the cap on foreign inflows (FDI banned in tobacco) had resulted in choppy stock performance and a company as big as ITC being derated by multiple agencies.

Even though the company has diversified into non-cigarette businesses like FMCG (non-cigarette), hotels, tourism, agri-products, stationery etc., its primary source of cash flow and revenues remains the sale of cigarettes.

But when you are engaged in morally questionable businesses (like tobacco due to their adverse health and environmental impacts), it prompts added layers of investor diligence (and conscience) before they put their money into stocks like ITC. Add to that a policy overhang caused by the Government’s will to reform tobacco-related laws and it adds volumes more impact to a stock which earns disproportionately from tobacco sales.

Concerns like these led to the rumoured proposals on demerging its cigarette business from non-cigarette ones like FMCG — Others, Infotech etc. This has been a war cry from shareholders from some time now, given the failure to unlock stock value despite having fairly-performing subsidiaries.

Hence, all the excitement over the just-concluded analysts meet. The event was heavily anticipated by the investor community to seek clarity on a number of questions ranging from ITC’s M&A strategy in the FMCG D2C brands, scale up in e-commerce operations, strategy to compete against brands like Marlboro, the FMCG business demerger, and even perhaps a dividend uptick or bonus stock issues etc.

But contrary to market expectations, the meeting largely turned out to be a non-event seeing as no major announcement was made.

Key Takeaways of the Meeting

1. ITC will firm up its capacity expansion to ₹10,000cr ($1.3bn) over the next three years which will be spent under the following heads: 25–40% in FMCG, 25–30% in paperboards and 10% in hotels.
2. Demerger of the FMCG business and listing of the Infotech business haven’t been “ruled out”.
3. The company will look for “growth triggers”, “premiumisation” and focused M&As going forward.
4. Exports in the FMCG segment will be prioritised. The company will also aim to unlock its potential-filled personal care segment.
5. The hotel business will concentrate on an asset light model.
6. ITC is currently 41% energy-reliant on renewable sources which will increase to 50% by 2030.

Regardless of the outcomes, analysts have termed ITC’s readiness to host the meeting — a long-standing investor demand — as a welcome step in company’s disclosure and governance. Sanjiv Puri, ITC’s Chairman, remained optimistic about more M&As in the FMCG space, given that they are value accretive.

While FMCG is to remain the key growth pillar of its business, given the dormancy in e-commerce salience of its brands (c. 7%), new methods of market expansion are likely, such as direct marketing, tie-ups with QSR chains etc.

In general, there were no key flashy updates at ITC’s maiden analysts day and was more of a rehash of the same. The stock had perhaps priced in a fair degree of optimism as demonstrated by the run up only to remain muted after.

A Closer Look at the Company’s Core

Say what you will about the company’s underperformance, but ITC remains a cash cow that is almost unmatched in its yield in corporate India. The company generates roughly $2bn in cash every year, mostly from its tobacco business. It witnessed a free cash flow worth ₹31,000cr ($4bn) over a three-year period, which translates to a free cash of ₹25 ($0.3) per equity share. In a world where recent IPOs are struggling to generate profitability, let alone free cash flow, ITC perhaps offers something for the yield-hungry investors.

But given the mismatch in its industry-wide trading ratios, this cash-generating machine falls meaningfully short. HUL and Nestle, ITC’s FMCG peers, boast lofty P/E and EV/EBITDA ratios north of 50x owing to their consumption-oriented business model and high growth prospects.

ITC, however, hamstrung by the investing lull in the tobacco segment (despite high revenues), has EV/EBITDA and P/E ratios of sub 20x. In fact EV/EBITDA has historically been in the sub-20x range. It is this valuation mismatch that prompts the FMCG carve-out play to drive a value unlock.

The tobacco industry may have supplemented ITC’s growth cycle but in a world that is increasingly aware of tobacco’s dangers will continue to view tobacco-related businesses with reinforced pessimism.

One could argue that carving out the tobacco segment could be the desired way for ITC to escape the ESG concerns and clean out the business.

But the question remains, carve it out into what? If you stop milking the biggest cash cow in your farm, where does your cheese come from?

Sure, the ESG-focused investors could make a comeback and ITC could regain its lost foreign shareholdings (declined from 18% to 13% since 2018). Valuation of standalone companies (like the Infotech segment) could receive a boost as well.

This is something that has been done before. For instance, L&T has almost doubled in its market cap since it spinned off its Finance, Infotech and Technology Services. L&T Infotech, in particular, has risen by 9x since listing.

But, demerger and listings are long-drawn corporate processes which take several months, sometimes even years, for a company as big as ITC. So one may wonder if focusing on profitable segments and a tapered breakaway from the tobacco business could be a more advantageous business strategy in the long run to escape the ESG quagmires and condemnation from the investors.

Only time, or ITC’s next analysts meeting, will tell.

(Originally published December 15th 2021 in transfin.in)