ValuePickr Forum

ITC: "Will"(s) "Gold Flake" assist "Ashirwad" to win "Bingo!"?

Background:
Established in 1910, ITC is the largest cigarette manufacturer and seller in the country. ITC operates in five business segments at present — FMCG Cigarettes (since inception), FMCG Others (since 2001), Hotels (since 1972), Paperboards, Paper and Packaging (Since 1977), and Agri Business (since 1990).
More details are provided on company website:
https://www.itcportal.com/about-itc/profile/history-and-evolution.aspx

Segmentwise details:
Since the company has presence in multiple business, it may make sense to look segment financals provided by the company over the period. Since 2002, ROCE of the company increased from 40% in FY02 to 135% in FY19. FMCG -Cigarette ROCE improvement (despite lower sales growth) has been main driver to growth in ROCE. Hotel /FMCG-Others/ Agri business has mediocare ROCE (less than 10%) over the years. The company valuation are partially adversely affected by adverse capital allocation decisions of management in Past.
image

Positive Consideration:

  1. Attractive valuation:
    At current price of Rs 160 (19 March 2020), the company is trading at lower than April 2012 close of 163 (31 times PE). From FY12-FY19, PBIT has almost doubled. Current TTM (trailing twelve months) PE of around 13 was last seen in September 2003. So current valuation appears modest if one compare with historical valuation parameter of the company.

  2. Among most productive distribution
    I have compiled from various public information sources for various peers of ITC about retail outlet for distibution with March 2019 (or latest Audited sales) in Rs crore for various player. While the information has scope for factual imperfection, still from the compiled information, I find ITC having highest sales per retail outlet among Indian players.
    Enclosing extract of my working:
    image

Building world lcass brands on leveraging on distribution network:
The company manage to scale its non-cigarette FMCG business over the large distribution network it built over the years.
image
The company has scaled up sales very well with almost no presence in 2000. It is also important to note, that the company started its Other FMCG business by entering into Expression Greeting card and WLS Lifestyle brands. In both these businesses, due to change in market dynamic, it was not able create impact and hence exited the business. However, the learning from failure has been used well by creating large brands.

3) Environment friendly operaton
The company has unique identification of being only company in the world to be Carbon positive (since last 14 years), Water positive (Since last 17 years) and solid waste recylcing positive (since last 12 years). This information is sourced from Sustainability report of the company. The company has been publishing sustainability report since 2004 which provide very good insights about company efforts in sustainable growth.
https://www.itcportal.com/experience-itc/index.aspx

4) Cigarette: Giant cash generating machine:
Despite volume de-growth and high taxes, the company enjoy great dominant market position. The company has till now manage to successfully pass on tax hike and also improved profitaiblity in Cigarettte business. ROCE in this business improved from 100% in FY02 to 388% (yes, I mean it) in FY19. PBIT from Cigarette business has grown at 14% CAGR over 17 years to reach Rs 15,412 Cr during FY19, which account for nearly 80% Consolidated PBIT of the company. This increase in PBIT needs special attention in the context of multiple hike in tax/lavies and negative volume growth during significant period under consideration.

Negative Points:
1) Adverse capital allotment
While the company generate large size of cashflow from Cigarette business, same are not utilised appropriately. Capital allocation to Hotel business is neglible 3% in FY19 and FMCG-other segment is around 6% in FY19. The ROCE of Agri business and Paper business are moderate at around 20%+ in FY19, still much inferior to Cigarette busniess.

While, hotel is definitely deserve special attention (or divestment) in my limited understanding, I would see FMCG-Others as future growth driver and Agri and Paper being critical support to growth of FMCG business. Nearly 1/3 of Agri business and Paper Business sales in value being utilised by the other segment of the company. Investment in Agri business is also critical for sourcing of Tobacco and wheat. More details are provided in E chaupal section. I personally would look at Agri Business as core component of business and would merge it with FMCG business.

While there is scope to hive off Paper business generate higher than cost of capital, still, none FMCG players have ventured into Paper business and highly successful. Hence, in my understanding, the company can improve ROCE by divesting from ROCE diluting non-core business of hotel and paper.

2) Higher Management Compensation
While BAT own ~30% stake in company, they are still not in control of operations. In past, the top managment (during 1990s) have defied BAT efforts to increase its stake to majority with support of Indian financial institution (specially LIC+SUUTI+General insurers), which own around 29% stake in company, and further 7% by MF which take difficult for BAT to control the operations.

Since, there was no entity in direct control, the remuneration to employee is relatively more relaxed in ITC. During FY2005-FY2019, Total ESOP cost (in respective year accounting standard) is around ~ Rs 4,000 Cr. Enclosing yearwise ESOP
image

On positive side, the employee has contributed around Rs 19,763 Cr towards ESOP. While it is difficult to understand how much shareholding employee currently hold as employees might have sold share in stock market post excersing ESOP, still amount involved is substantial enough align employee interest with wealth creation in my opinion.

3) Sin product and not fitting ESG requirement
One of reason for lower relative valuation of ITC as compared with peer companies is due to Cigarette being not good for society health. As a result, many institution are liquidating their holding in ITC and future demand for shares may be limited despite improved financial performance. Government also find Cigarette industry when it need to look out for additional resource to mobilise welfare for regular and contingency plans. This may continue to adversely affect ITC valuation in my personal opinion.

It may be noted that significant share of value addition in ITC is also shared with Government. This factor may provide sufficient breathing sector to keep going .
image

Barriers to Entry:
1) Regulatory constraint
Cigaretter has huge regulatory entry barriers as license to manufacture are not issued to new players. Also, there is no scope for a new player as advertising of product is not permitted.

2) E Choupal: An Indian micro entperising effort
Since 2000, ITC has develop an unique social infrastrcuture called E Choupal which reaches to rural area and farmers. One reason for successful brand building and having more than 40% market share by Ashirvad/Bingo to procurement of woods for paper is direct access to E Choupal.
image

Summary:
While there are issue about high taxation, inferior capital allocation and not fit to attract financial investor, given the valuation comfort and scope to improve margin in FMCG products and recent announcement of higher dividend payout, ITC may be interesting company to watch for.

Also, enclosing return for an investor who has invested in ITC IPO (not particpated in right issue and other issues) and calculated holding total shareholding return since 1970s. The XIRR for investor are 24.3% p.a. over 5 decades decades !!! This is excellent TSR for sure in my view. Having said that, past may not be indicative of future and hence one has to evaluate business propsect and growth before making any investment.

Disclosure: My view may be biased due to my investment. Bought share in last 15 days. Not a recommedation, Not SEBI registered advisor, Reader shall do his/her own due diligence before making any decision
ITC Past return 1971-2019.xlsx (24.0 KB)

35 Likes

Thank you for the detailed post. I too started following the stock over the past few days and the only thing I am not able to convince myself is the growth drivers of the company. I can very well understand that the company has been around for more than a century now. But where is the potential for future growth? With the latest modification to the company’s dividend policy, there are no big capex plans for the future. On the other hand, I recently read somewhere that the company would launch new products this year in the FMCG segment. Do you think with heavy competition in FMCG, ITC is in a good position to navigate and win?

Disclosure: Invested

1 Like

Cigarette business will always be a cash cow and slow grower as government depend on it. Hotel business can be left aside. Significant growth might come from FMCG with agri, paper supporting it as margins, revenues, profits , return on capital improved well over the years. As per HDFC securities report, Gross margins for FMCG business are at par with peers but net margins are low due to product gestation costs. Company has already planned to invest around 25000 cr towards various business segments and launch around 50 products in the next year. So the new dividend policy actually depicts the financial strength of the company and will also reward shareholders. Lastly, despite huge competition from MNC, it has been able to build #1 #2 #3 brands across different segments over the time. By the way company has research centre comprising of 350 qualified scientists who work on building innovative products.
Disc : Invested

6 Likes

I like the title of the topic. Good to connect to you again @dd1474 after BSE. There are plenty of useful posts in HUL & ITC thread… I am reposting some of my contributions here…

1 Like

In my opinion Coca Cola should also be considered sin stock, selling high sugar beverages, responsible for so many diseases and deaths.

7 Likes

I believe people are different in their judgement of what is sin, what is moral, what is justice etc… What I consider as sin may not be so, for another person.
And isn’t it the result of how every individual’s brain is wired ? I think so !
Disclaimer: I drink USL and I smoke ITC :wink:

3 Likes

Well I agree with first level impact about Cigarette not being good for society in general. Having said that, who are major beneficiary of the Cigarette industry? If one read ITC publication (AR /Sustainability report/ Presentation), governement get around 73% of Value addition (calculated as Sales- Raw material cost, in my understanding). So the majority of value creation is taken away by Government from Cigarette industry which MAY BE using for funding health and other welfare scheme. Further, Cigarette account only for 10% of Tobacco consumption in India but have 86% of revenue generated from tobacco Sector.

While your concern is very valid, investment is process where each person has its unique profile and portfolio. What is medicine for someone may be poison for other. Hence, respect your view, but I am fine to invest in Cigarette companies.

8 Likes

Fair enough. Thanks for explaining the stand. But I am trying to understand what are you trying to convey by this post here. Are you suggesting us that we should feel guilty and not buy ITC ?

With all due respect to your and everyone’s thoughts - ITC echoupal is a blessing to many underpriveledged in India. CocaCola - spreading diabetes in children may be even sin to some other eyes. ITC is a company which has acknowledged that it wants to grow in non-sin businesses and probably thats where incremental capital of investors go. Regarding liquor - Some would say that liquor companies are not Sin, but irresponsible drinking is. Even Wellness companies selling Sugarfree has chemicals more harmful than plain crystal Sugar to the body. Also, I read ITC plans some hospitals not for profit. Many herbal companies sell chemicals in name of Ayurveda…

Nothing against anyone’s personal thoughts - every company has their own Sins, so has every man :slight_smile: Best Wishes

5 Likes

Respected bro, Everybody is free to express his / her opinion. Simplistically, my comments should be read as an expression of my opinion that i don’t want to taint my hard earned money derived from day job by investing in sin stocks and thereby making the returns tainted.

As far as i know, there are far more available opportunities to make money after this crash rather than investing in ITC / liquor stocks/ financial institutions which charge exorbitant interest rates of above 20% when the world is moving to 0% interest rate. I shared my view that i don’t want returns from ITC which earns significant portion of its revenue from cigarettes. Even when there are no opportunities to make money due to significantly high valuations, i wont invest in sin stocks for the sake of my upbringing or the morality I’m having

All are free to express their views and when i own a stock, i intend to pass it to the next generation. Similar to all long term investors here, i use dividends for reinvestment as long as i have a day job. Thereafter use the dividend to cover my expense and bequeath my portfolio to the next generation. However, i don’t wish to pass on a sin stock to my next generation or use the tainted returns derived from such stocks to feed myself / family. I wish to keep my money untainted which is linked to my state of integrity or morality or whatever term you wish to call

I may consider buying ITC once they demerge the cigarette business. Until then it’s a strict no from my end

Happy investing

Cheers,
Mathews

2 Likes

Fellow members, I request let us have discussion on business and financial performance of stock. While many find Cigarette industry as not being fitting their portfolio parameter and I think that is perfectly fine. However, they should also reciprocate same to people who are exploring and do not find anything wrong in investing in Cigarette industry. We all are mature and understand pros and cons of investing. Last 6-7 messages on the thread are about ehtical value and other issues which I think does not add much value to investing and core of ValuePickr values for sure. Henceforth, if any member want to put comment in support or opposition of ITC investment, please express same by like message of view on threads rather than putting a new post. I will mark any new message related ehtical side of investing (supporting as well as opposing) as inapporiate. I hope my fellow member would show discipline and kind enought to accept my rude behaviour.

Thanks and regards

18 Likes

Point well taken. I do not have any doubt about cigarette being not good business for society. Hence, my investment base is cashflow from cigarette used in FMCG business which is strong and sustainable over relatively long horizon. So cash cow getting utilised to build sustainable business. Cigarette revenue may decline but in 3 years or 30 years is main question. I believe it would be slow decline and by that time FMCG business would have scaled up to take it to another horizon. My assumptions have gone wrong more than right and hence I am mentally prepare to right my learning from ITC after 3-4 years on same thread :slightly_smiling_face:

6 Likes

All are requested to stick to the discussion on business. Morality point is put & is fair, but it should not be the center of discussion. All are requested to tone down their replies. I know the market crash is hitting our heads but this is the time we have to be more polite & humble. Learn to respect counter views.

14 Likes

As we know promoter holding is 0 in ITC. I was wondering how important is this from a value creation point of view. (The only other large company (outside financials/insurance ) with 0 promoter holding is L&T.). I am not talking about it from a free float perspective. But the commitment/passion from top level management. They are all just normal employees with no real stake. ( Other than some ESOP which may not be big in the overall scheme of things). Do we have any case study (Global or Indian) where there are no promoters.?

1 Like

Good point and I had same thoughts. Now point to think is having promoters can sometimes, which is more often than not, backfire also because of their unrelated businesses, aspirations and in some cases frauds. So this can be a good thing also. Also BAT is a significant shareholder and so is GOI and these or others long term shareholders would make sure that management has the drive and long term intent. That’s how I put this point to rest. More views on this unique aspect of no promoters is welcome as it will good to learn, specially from global perspective. Thanks

2 Likes

Many thanks for the detailed standalone topic on ITC, it was much needed.
Few points which I think we can add to your note for completion:

  1. BAT has voted against the ESOP policy (they don’t want their stake getting diluted) so going forward there will be no ESOP. Also ITC may not want to increase BATs stake, so no buyback in the future should be expected.
  2. SUUTI stake sale overhang - around 8% holding they have of ITC

Technically Rs140-150 closing levels are strong support and stock has bounced back on the positive news of the dividend distribution policy.

disc - Biggest holding in my PF

4 Likes

ITC has cut sanitizer prices for 77 to 22 that is pretty massive cut.

1 Like

Government has put a price cap on hand sanitizers… 200ml capped at 100rs…hence all the companies have bought it down… HUL, ITC AND Godrej consumer products… Few companies I know…

1 Like