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

[rajanprabu]

To get a better context on why ITC demands a premium, let us compare the growth in Cigarettes and FMCG divisions

FMCG Revenue growth % in FY 23 March quarter

Company	YoY	QoQ
ITC	19	2.2
HUL	10.5	-2.5
Brittania	13	-4
Marico	3.7	-9
Godrej Consumer	9.8	-9
P&G	-10	-22
Nestle	21	13
Dabur	6.4	-12

As one can see even when it comes to quarter on quarter comparison, only ITC and Nestle showed revenue growth while other FMCG giants sales declined. Hope the trend continues.

Cigarette Revenue growth % in FY 23 March quarter

Company	YoY	QoQ
ITC	13	-0.05
Godfrey	14	-12.6
VST	-0.3	-12.7

NTC and Golden Tobacco are below 100 Cr cap companies… Although Jaipur red, Maypole cigarette maker NTC did pretty well last year. But scale at which other tobacco makers operate makes it incomparable.

Just to put things in perspective.

Note: Same holding as last post but no transactions last 30 days. Please do your own due diligence.

[Mayank_Bajpai]

I will not cover what ITC does, but will straight away jump into Ratios to understand more insight about the business and recent run.

Cigarettes Business: The Engine of Profitability:

ITC’s cigarette business continues to be the primary driver of the company’s impressive EBIT margin growth. Despite regulatory challenges and increased awareness of health concerns, the sheer volume growth in the cigarette segment has proven resilient, maintaining its financial prowess within the organization. By leveraging its established brand equity and distribution network, ITC has managed to navigate through headwinds and sustain its dominant position in this sector.

Agri/Core FMCG: A Tale of Limited Progression:

In contrast to the thriving cigarette business, ITC’s Agri/Core FMCG division faces challenges in achieving a significant jump in growth. Despite its strategic foray into diverse product categories, including packaged foods, personal care, and home care, the performance of this segment has yet to mirror the remarkable success of its tobacco counterpart. Factors such as fluctuating commodity prices, supply chain complexities, and intense competition have posed hurdles for ITC to achieve exponential growth in these markets.

Debunking Misconceptions:

While ITC’s diversified business portfolio may spark conversations about its potential sources of profit, the reality remains that the lion’s share of its financial success is derived from the cigarette segment. Oftentimes, speculative narratives about alternative growth drivers overshadow the robustness of the company’s primary revenue stream. As investors and stakeholders, it is crucial to acknowledge that the key to ITC’s continued profitability lies in understanding the core strength of its cigarette business and its implications on the overall financial performance.

Lastly, another factor like not increasing the taxes by the Government on the tobacco business and volume growth in the cigarette market reflects in the recent stock run.

Let’s look at the fact below -

Let’s look at the Ratios and understand the importance of the Ratio:

If we look at the ratio very carefully, we see an immense jump in the ROCE for the cigarette business, have you ever thought why is that?

Let’s decode together, due to the nature of the cigarette business ITC does not need a high ROCE but due to High Asset Turnover, Margins are high, and Working Capital is low that directly has an impact on the insane ROCE percentage.

Conclusion:

In conclusion, the recent EBIT margin growth in ITC’s business is intrinsically linked to the relentless performance of its cigarette segment. As the cornerstone of the company’s financial success, the cigarette business continues to dominate the revenue landscape.

[rajanprabu]

@Mayank_Bajpai

In contrast to the thriving cigarette business, ITC’s Agri/Core FMCG division faces challenges in achieving a significant jump in growth.

I would disagree with this observation. If we look at FMCG business Revenue grew from 5000 Cr to 19153 in the last 10 years and thats about 13 % CAGR. HUL grew by 8% while Britannia grew by 10 %. Thats an industry beating performance. Probably one will be disappointed by profit growth although margin improved from -4 % to 7% in the very snapshot that you have posted. But gestation was necessary for FMCG products especially at the scale ITC operates. I wrote about how HUL behaved during 1990s and how it margins went higher with scale & time here.

Hindustan Unilever (HUL)

FMCG margin has been consistently getting better. I have attached a snapshot from HDFC Q2 report below. [18] HDFC also said in a side note that ITC’s gross margin is at par with peers ( 40-45 % ) but low margin is due to Higher upfront brand investments and Losses in retail business. FMCG EBIT margin expansion was driven by enhanced scale, product mix enrichment and cost management initiatives notwithstanding higher investments in brand building and gestation costs of new categories. Everyon…

Although ITC may not reach the margins are HUL due to different product mix, better comparison is Britannia. Britain’s Margin ranges between 15 and 20 % ( probably based on wheat prices ). I do expect ITC to reach that margin range. In the last quarter ITC FMCG did 10 % margins. They aspire to increase margins by 100 bps every year. Interview posted above by Harsh.

@Mayank_Bajpai

While ITC’s diversified business portfolio may spark conversations about its potential sources of profit, the reality remains that the lion’s share of its financial success is derived from the cigarette segment.

I dont think anyone would say otherwise. Cigarettes dominate the profits and margins obviously due to the kind of business it’s in. Other sectors will never reach such margins for the same reasons.

@Mayank_Bajpai

the cigarette business continues to dominate the revenue landscape.

True for profits but revenues of other sectors have been growing consistently.

@Mayank_Bajpai

As investors and stakeholders, it is crucial to acknowledge that the key to ITC’s continued profitability lies in understanding the core strength of its cigarette business and its implications on the overall financial performance.

Everyone acknowledges that and one should not underestimate the investors especially those who read ValuePickr. Market always prices for future and future prospects of ITC played a role in revaluations along with robust performance of Tobacco division.

[Mayank_Bajpai]

@rajanprabu

I would disagree with this observation. If we look at FMCG business Revenue grew from 5000 Cr to 19153 in the last 10 years and thats about 13 % CAGR. HUL grew by 8% while Britannia grew by 10 %. Thats an industry beating performance. Probably one will be disappointed by profit growth although margin improved from -4 % to 7% in the very snapshot that you have posted. But gestation was necessary for FMCG products especially at the scale ITC operates. I wrote about how HUL behaved during 1990s and how it margins went higher with scale & time here.

Thank you and I appreciate taking out time and sharing your view. Please refer to the EBITDA margins of the FMCG business for the last 3 years and let me know the growth. You will see almost nil to no growth in the Margins.

[Mayank_Bajpai]

@rajanprabu

Although ITC may not reach the margins are HUL due to different product mix, better comparison is Britannia. Britain’s Margin ranges between 15 and 20 % ( probably based on wheat prices ). I do expect ITC to reach that margin range. In the last quarter ITC FMCG did 10 % margins. They aspire to increase margins by 100 bps every year. Interview posted above by Harsh.

Well, they keep saying that and I will personally not invest until they show it on the P&L.

[Nitin_Naudiyal]

Got this from their recent investors presentation.

[Mayank_Bajpai]

Please check for Annual - from P&L

[rajanprabu]

@Mayank_Bajpai

Please check for Annual - from P&L

With all due respect what you are looking at is PBT Profit Before Tax. John Malone who is attributed for coining EBITDA wanted a more accurate measure of the performance of a company that had a rapidly increasing cash flow but was spending most of it on further expansion. ITC did lots of capex in the past and still expanding.

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

There has been lots of questions about ITC and its Capex on FMCG. I wrote a bit about this on the HUL&ITC forums… some are replicated here along with updated numbers. Snapshot of ITC fundamentals, Capex and valuation numbers last 10 years. Its not dissected( as Dhiraj did above) into parts but ITC as a whole. [ITC_2020-03-29 at 11.07.53] ITC started speaking about 25,000 Cr Capex around 2012 or so… They wanted to do the investments across all verticals… Since they they did a Capex of ar…

so EBITDA is a better measure than PBT. ITC reports this in the footnote of each quarter results.

As @Nitin_Naudiyal posted EBITDA margins are indeed expanding. From a mere 2.5 % to 10.2 %. In fact in Q4 FY23 EBITDA margin expanded to as much as 13.3 %.

@Mayank_Bajpai

Well, they keep saying that and I will personally not invest until they show it on the P&L.

I am quoting the data points. Of course it’s your call.

I dont want to clutter the thread, so I stop here.

[devarshi84]

897ED76C-2E9F-4E8E-B585-20BD0D8EA4A2-121731.pdf

The usual clarification without any clarification like everytime. It is going to be tough to arrive at a conclusion that is agreeable by both govt and BAT ( provided govt can come to a conclusion first).

On another note, ITC has not been able to start any new venture in recent times. They were to start hospitals and get into neutraceuticals. Even the nasal anti-covid spray was announced but nothin concrete has come up.

ITC plans to set up multi-specialty hospitals - ET HealthWorld

ITC explores ways to venture into health and wellness market

[Mayank_Bajpai]

ITC has announced the demerger of its hotel business. Following the demerger, ITC will hold 40% of the hotel business and the remaining 60% will be held by a minority. The shares of ITC fell by 2% after the announcement. The reason for this could be due to the holding company discount that will prevail.

[dd1474]

ITC has put presentation on Stock exchange explaining demerger strucutre.

dd8c529d-569d-48b3-a6a5-20775e32469a.pdf

[investor12321]

@investor12321

The shareholder-friendly way to go is to spin it off to shareholders; listing a minority stake only fructifies the Holdco/conglomerate discount and doesn’t do much for shareholders.

As mentioned earlier, this is sub-optimal for the minority shareholders, which is reflected by the share price reaction immediately after news release.

Assuming a 10x Sales multiple - price would be about 25k cr.

BAT will hold about ~17.5% (29%*60%) of the resultant entity which it will look to exit ASAP (towards deleveraging and divesting non core exposure)
BAT’s stake would be worth £400m - they’ve got an earnings call on the 26th.

[Investor_No_1]

@investor12321

As mentioned earlier, this is sub-optimal for the minority shareholders, which is reflected by the share price reaction immediately after news release.

could you pls explain with some numbers of what would the spin off you consider optimal here? do you mean a case where instead of ITC holding 40% of demerged hotel business, they would directly hold nil and all 100% directly held by current shareholders?

if yes, then how is that better for existing shareholders than current 60-40 structure? Also, what must be the reason amd logic for ITC to follow this 60-40 structure instead of full 100% or any other structure? Is there any rule governing such demerger structures or a company can chose any such ratio? Thanks

[Vinay_T_M]

In FY23, hotels contributed ~540 cr to ITC’s operating profits, just over 2% of the company’s total profits (~24000 cr). If we compare it revenue-wise, it is 2500~ cr vs 70000 cr (3.5%)

Mind you, this is a business that is highly capital inefficient and there will not be any incremental capex. The value of this business is not going to be significant irrespective of the valuation method one follows (max 15-25 on a per-share basis). In the grand scheme of things, it doesn’t really matter if they demerge it or delist it or sell off the assets for cash. The investment bankers stand to benefit here from this demerger and there is not much for other stakeholders

Hotels has always been viewed as a problem by ITC shareholders and everybody wanted it to be thrown out. Now that the share price has cooled off by some 3-4% today post-announcement, all of a sudden people are complaining that this is unfriendly for the minority shareholders (as if the management cared about our views before), there will be holding company discounts, BAT will sell-off their stake etc…Really want to understand why were these things not up for debate earlier. What part of the information was unknown or a negative surprise here? BAT selling pressure after demerger was never a surprise, holding company discount was also going to come into the picture. This is just panic selling and there is no logic to explain a 4% fall in stock price for a business which anyway was never contributing to the same number in ITC’s share price

Stock picking is an act of arrogance as many say. “Where you see threats, I see opportunities” is what every investor thinks of. Not gonna debate if the current mcap of ~6 lakh crore is fair or not but why is nobody talking about how drastically the return ratios will improve post-demerger? This definitely would have been the topic of discussion had the stock price shot up 4% today. Waiting for brokerage reports on how the ROE and ROCE will shoot up say 30% once the asset-heavy business (~8000 cr assets) of hotels is demerged. That narrative will be used to justify if/when the stocks price goes up

To most retail investors (including me), reading all the news coverage and everybody saying this is good/bad is just a waste of time. This is nothing but noise for a long-term shareholder who would’ve anyway known how insignificant hotels is in the big picture. Now that I have used up 20 minutes of my time writing this, I would advise folks not to waste more time on this topic

Disc - invested

[investor12321]

In my opinion, the most optimal thing is a full spinoff whereby ITC Ltd would offload the entire ITC Hotels stake to shareholders.

Benefits of this are:

1. Holdco discount eliminated (so full value unlock)
2. Shareholders can choose which businesses they want to participate in
3. Full spinoff is tax free (now if ITC wants to reduce stake - they’ll pay taxes)
4. Fully independent board and management (not just a puppet of ITC mgmt - for now, I assume ITC Ltd will effectively be a promoter)
5. Capital allocation independent of ITC, focused on ITC Hotels and ITC Hotels minority shareholders ONLY
6. Potential for ITC stake sale will continue to be a overhang

Think of an alternate universe where HDFC Ltd would sell the mortgage business to HDFC Bank and offload AMC, Life, Ergo stakes to shareholders. Shareholders get to choose which line of business they want to participate in and have a much higher value unlock due to all the shares they receive.

or what Adani Enterprises did in 2015. Each of the Adani businesses was able to chart its own course.

[investor12321]

Absolutely - ITC Hotels could vanish overnight and shareholder value would effectively be unchanged.

Why this is an important thing to discuss and debate is because it tells you how the management thinks and manages the rest of the 6lk cr of value.

[Nitin_Naudiyal]

With less than 4% of contribution to the overall business, hotels used to command around 15-20% of capital generated by the other business, mainly Cigarettes.

With this Demerger hopefully capital allocation will improve and this should help the FMCG business in the long run.

[Shubham_Jain1]

I still fail to see how this improves the capital allocation though.

As per my understanding, all the other business lines are given sufficient funding, so at the end it boils down to dividend vs hotels business. Their might have been some missteps, but we start to look at every negative point when stock isn’t doing well, and everything becomes better once stock starts to perform.

Also their hotels are premium, which is unlikely to give yields now, but this is a play on premiumisation to a certain extent, and can help with their premium FMCG category. So I am not sure whether it can be considered a wrong business decision, even if it didn’t turn out to be a good one till now.

[manishdhariwal]

I could not understand the benefit of keeping 40% with itself. It basically reflects that the existing mgmt of ITC doesn’t wish to let go of this business… the demerger is therefore, just a sham. They had already promised an asset light strategy going forward… so what has changed

[Garuna]

40% has been retained to keep majority stake in case BAT sells its stake in the de-merged entity to someone else. (Which they can).

With a business like ITC, de-merging is not without risks of new entity being eaten up by a third party.

But that 40% also belongs to the shareholders, proportionally, so the market reaction today was knee-jerk to say the least.