VST Industries: Puff full of power?

Stock Opportunities Not-so-Hidden Gems
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Background

VST, originally incorporated in 1930 as Vazir Sultan & Son, became an associate of British American Tobacco Plc. (BAT) over a period of time, which holds a 32.2% stake in VST Industries. Post-acquisition of stake by BAT, the named was changed to Vazir Sultan Tobacco Company Limited, and further in 1984 to VST Industries Limited. In the early 1970s, the Government of India directed all companies coming under the Foreign Exchange Regulation Act (FERA) to reduce foreign shareholding to less than 40 percent. Consequently, BAT’s stake in VSTIL got reduced to 32.6 percent.

Post Liberalisation, in 1993, the company has failed efforts in diversifies in real estate, Agri processing and financial services, which resulted in large losses during FY1999. With support of BAT and difficult strategic decision to focus on core business, the company again resumes its part of profitable growth.

In February 2001, Radhakishan Damani, India’s savviest stock market investors, astonished the market by making a hostile bid for cigarette maker VST Industries, owned by British American Tobacco (BAT)., Damani had accumulated below 15 percent in the company over the last year at an average price of 88 per share. But ITC which entered the fray as a white knight and foiled it with support from BAT. Damani still holds 26 percent in VST Industries.

The company is mainly engaged in manufacturing and marketing of cigarettes, and trading of unmanufactured tobacco. VST is the third largest cigarette manufacturer in the country, operating mainly in the lower end category of the industry. VST’s flagship brands include Charminar (since 1994), Charms Virginia (since 1997), Special Extra Filter (since 2004) and Moments (since 2007).

https://www.asci.org.in/journal/Vol.33(2004)/03.%20H.%20Hemnath%20Rao.pdf

Positive:

Strong cash generations:
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High Entry barrier

As cigarette being not good for health, the government has banned promotion of cigarette through advertisement in television. Also there is good efforts to promote bad effect of cigarette on health, specifically by pictorial warning on cigarette pack, cancer related issues due to cigarette consumption. Also, the government has banned new capacity of cigarette. While all these factors have resulted in degrowth of cigarette consumptions in India, same has also resulted in very high entry barrier in the sector. There are only 3 large players which control around 90%

Negative factors

"Sin" product

Tobacco consumption has been major factor driving cancer and other health related disorder. The government has taken various action on controlling the tobacco consumption including increasing various taxes on cigarette. Being an addiction, the rise in cost/taxes are passed on to the consumer, who has very limited choice to avoid consumption due to addition. Hence, while the cigarette business may provide stable cashflow to investor, it is not be good industry from society value perspective. Also, over a long term, the industry growth is expected to remain negative as reported in Developed market with increasing per capita income and awareness.

Growing illicit cigarette market in India

While there is high entry barrier of entry in Cigarette sector, same is applicable only to organised sector. As per ITC Corporate presentation, the legitimate cigarette industry has declined steadily since 2010‐11 at a compound annual rate of 4.8% p.a., illegal cigarette volumes in contrast have grown at about 5% p.a. during the same period, making India one of the fastest growing illegal

Cigarette markets in the world. So higher tax on cigarette from organised along sector, along with very high portion of pack being covered gruesome images adversely affect safety perception of domestic cigarette in India and increasing share of illicit imported cigarettes.

High Valuation

VST Industries is currently trading 25 times PE on TTM basis. Since March 1997, average PE multiple and Median Multiple for the company is 14.37 times and 14.12 times. Hence, valuation of the company has limited, rather no margin of safety if considered with past parameters.

Rationale for investing

After 4-5 years of negative volume growth, resulting for various factor, VST Industries as well as orgainsed cigarette industry have shown positive growth from last 2 quarters. I have relied in ICICI Direct report on VST Industries in Jan 2019. The relevant portion of report indicating positive growth is enclosed.

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Further, December 2018 results TTM EPS Rs 143, with dividend payout ratio of around 70%, may result in increased dividend to Rs 100 per share in FY20 for VST Industries. Since I like stable dividend investment, I expect VST Industries to provide for 2.7% Dividend Yield as on Current price (Rs 3600). The share price movement would depend on how industry growth revive and I have no view on same. Further, at current level, there is limited margin of safety for investor in my opinion. However, this may be good stable dividend generating idea if an investor is looking at investing for 3-5 year horizon.

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Past Dividend, Share price and PE for VST Industries

Year End Dividend % Dividend Rs Share price TTM PE Div Yield
Mar 2018 775 77.50 2,919 25.23 2.7%
Mar 2017 750 75.00 2,880 25.95 2.6%
Mar 2016 700 70.00 1,620 17.31 4.3%
Mar 2015 700 70.00 1,607 15.18 4.4%
Mar 2014 700 70.00 1,649 19.14 4.2%
Mar 2013 625 62.50 1,505 18.12 4.2%
Mar 2012 650 65.00 1,457 16.96 4.5%
Mar 2011 450 45.00 640 10.4 7.0%
Mar 2010 300 30.00 521 10.49 5.8%
Mar 2009 300 30.00 225 4.62 13.3%
Mar 2008 200 20.00 309 9.51 6.5%
Mar 2007 200 20.00 330 8.64 6.1%
Mar 2006 125 12.50 482 17.44 2.6%
Mar 2005 125 12.50 231 6.6 5.4%
Mar 2004 60 6.00 202 10.92 3.0%
Mar 2003 55 5.50 89 3.58 6.2%
Mar 2002 45 4.50 151 6.32 3.0%
Mar 2001 25 2.50 110 6.15 2.3%
Mar 2000 10 1.00 67 6.59 1.5%
Mar 1999 0 0.00 113 0 0.0%
Mar 1998 10 1.00 95 22.56 1.1%
Mar 1997 10 1.00 90 18.39 1.1%

Links:

ITC Presentation: https://www.itcportal.com/about-itc/shareholder-value/ITC-Corporate-Presentation.pdf

Screener Data: VST Industries Ltd financial results and price chart - Screener

Cigarette industry data Euro monitor: mid-priced cigarettes: Cigarette sales will continue to be under pressure in India: Report - The Economic Times

Disclaimer: I have been holding VST Industries since last 9.5 years and my view may be biased. I have recently increased my allocation to VST Industries by 20% of my holding in VST Industries in last 15 days. I am not SEBI registered advisor and investor shall consult his/her own investment advisor before making any investment decision.

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Thanks Dhiraj for starting this post on VST. One resource that comes to mind when thinking about this company is Prof Bakshi’s excellent post https://fundooprofessor.wordpress.com/2011/04/24/vantage_point/

The company is a helluva cash machine and they have been distributing most of the earnings as dividends. From Mr. Damani’s point of view, his average cost of acquisition would have been around Rs 75-80 in early 2000s and guess what, the company now pays this amount as dividends each year, apart from the capital appreciation of course. So that’s like a coupon with a 100% annual interest along with price appreciation.
No wonder he is a genius!

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I was going through Credit Suisse Global Investment Returns Yearbook 2015. Came across interesting insight about Tobacco sector in the book.

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Over a century, one industry which manage to remain relevant is Tobacco. Find above the market capilisation by industry in US and UK over the century.

The sector, not only survived, but also generated maximum return on all the sector since 1900 in US and UK market. Find enclosed relevant graph for same.
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I find the longetivity of industry and cashflow generating business interesting in context of recent reducing life of business.

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VST inddustries Q1FY20 was probably best ever results on all parameter. Sales and net profit grow by 24% YOY, RM cost decline and highest EBITDa margin in last 3 years (and best if compared with last 10 years data)
Amazing performance in difficult time. It would be worthwhile to note that performance is sustainable or not. May be all good things have materialise during the quarter and may not be possible to repeat such performance. However, growth in topline is very encouraging and same appear to be sustainable as 5 out of 6 quarters, the company reported more than 20% growth in Topline and bottomline.

Enclosing my working on interim finanancials

Rs Lakhs 30-06-2019 31-03-2019 31-12-2018 30-09-2018 30-06-2018 31-03-2018 31-12-2017 30-09-2017
3 months 3 months 3 months 3 months 3 months 3 months 3 months 3 months
Net Sales 30,468 27,263 29,299 29,022 24,317 27,914 23,897 21,991
RM 13,407 14,617 15,772 14,575 10,053 15,349 11,662 10,453
Employee 2,587 2,117 2,408 2,359 2,342 2,520 2,117 2,109
Other exp 2,960 2,414 2,490 3,065 2,332 2,083 2,130 2,429
EBITDA 11,514 8,115 8,629 9,023 9,590 7,962 7,988 7,000
EBITDA % 37.8% 29.8% 29.5% 31.1% 39.4% 28.5% 33.4% 31.8%
Other income 1,175 1,078 1,007 924 836 782 546 481
Dep 935 1,115 1,007 1,082 931 1,107 936 938
Int 0 0 0 0 0 0 0 0
PBT 11,754 8,078 8,629 8,865 9,495 7,637 7,598 6,543
Tax 4,186 2,775 3,085 3,152 3,371 2,804 2,622 2,142
PAT 7,568 5,303 5,544 5,713 6,124 4,833 4,976 4,401
Tax Rate 35.6% 34.4% 35.8% 35.6% 35.5% 36.7% 34.5% 32.7%
Capital (Rs 10) 1544 1544 1544 1544 1544 1544 1544 1544
EPS 49.02 34.35 35.91 37.00 39.66 31.30 32.23 28.50
RM/Sales% 44% 54% 54% 50% 41% 55% 49% 48%
Employee/Sales% 8% 8% 8% 8% 10% 9% 9% 10%
Overhead/Sales% 10% 9% 8% 11% 10% 7% 9% 11%
Other income/PAT% 16% 20% 18% 16% 14% 16% 11% 11%
YOY Sales Growth% 25% -2% 23% 32% 16% 27% 2% -2%
YOY PAT Growth% 24% 10% 11% 30% 54% 54% 10% 43%
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Hi Dhiraj,

Thanks for sharing above data. While I understand cigarette business is a long standing and repeatable business, wanted to know if such businesses can get higher PE multiples. A look at the fifteen year history of VST indicates an avg PE of 15 at max with 1 or 2 exceptions. What is your view on this?

With respect to Q1 results, I think VST’s product mix and price point is working in its favour. As per recent media report, ITC whose price point is higher than that of VST is re-aligning its strategy towards non-cigarette FMCG, despite cigarettes occupying a higher share of their FMCG revenue.

Regards
Iyer

Disc: Invested but no recommendations.

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Your view point is perfectly fine on average PE being 15 times. On second point is also a fact that, ITC the large professionally run ciagaretter company and intend to have better mix of non-cigarette FMCG products in order to minimise impact of “Sin” product and negative attribute associated with it.

While it is true that product has negative social implications and hence have limited growth potential, the limitations of no growth and negative government attribute also work as high entry barrier. The company has been great cash generator and distirubtor of cash. Whether can assign PE of 15 or 30 or 45, would be factor of growth propsect of business and market sentiment. I would leave it to individual to take call based on their risk profile and understanding of business.

Only another perspective could be revival of growth after almost 5-6 years of negative sales growth. If that is sustained, then I do see market rerating the industry and company. Having said that, at current level, market is already discounted recent high sale growth in my opinion. The growth in share price now would factor of sales growth being higher than 10% on 3-5 years period. If same materialise, there is scope for price appreciation. Otherwise, there is limited growth/negative growth in past in my opinion.

Disclosure: Holding my position and view may biased due to same. Not a recommendation

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Where are VST industries cigarettes sold? I have checked numerous of panwaala shops and no one yet have Charminaar or VST brand cigarette. In fact they don’t even know this brand.

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Isn’t VST industries very expensive? It trades at a similar valuation to ITC that is basically a monopoly and has household FMCG businesses etc: Dividend yields are similar as well.

Just trying to understand why VST trades close to the valuation given to ITC. Both are well known companies in the market.

Is there something else in VST that makes it trade at this price?

Either ITC is cheap or VST is rather expensive.

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VST industries has low free float thats the reason for high share price
ITC’s tobacco business is showing signs of saturation

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Company has several brands Editions ,Total , Charms ,Special Etc… I don’t think Charminar is still in circulation. They have pretty solid presence in Telangana and Andhra pradesh. I think they have presence in Maharashtra as well , I am not aware of other states.

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As the nature of their business does not encourage volume growth or advertising, VST has smartly invested their surplus cash in Debt Mutual Funds. So they could provide constant and increasing dividends yoy.

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They are cheap compared to Godfrey or ITC cigarettes , vst are kind of upgradation from bidi and cheap cigarettes. I have seen when ever there’s hike in price people migrate to VST from ITC. And I think the merchants also get good margin on vst , lot of small tea stalls and panwalas have vst cigs.

I read all over the world only cig companies are still in market from their IPOs and they are profitable e.g. India ITC, American Philip Morris , Japanese company forgot it’s name.

For vst they still have lot of market to grow cause India is getting younger and is earning more money to throw away on instant pleasures.

If someone had invested in 08-09 the price was 300-400₹ range now they are getting dividend of 85-90₹ with 10 times growth in stock price and 25-30% dividend it’s really fabulous.

Conclusion: As long as smokers are there growth will always be there, people knew 10-15 yrs ago also that cigs are injurious to health , still neither the volume nor the prices have shrunk. Unless govt bans there’s no stopping.

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Old article but can help us out

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Stock made new 52 week high today and closed near it …any expectations on the result?

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VST Industries reported very good sales and net profit for Q3FY20 in my view. Recored quarterly sales and net profit for the company.
Net Sales (net of excise) increased by 11% as compared with Q3FY19 and Net profit increased by 29% as compared with Q3FY19.

Evern sequentially, the company reported growth on net profit.

Discl: My view may be biased due to holding in the company. Not SEBI registerd advisor. This is not an investment recommendation. Reader shall consult investment advisor before taking any investment decision.
https://www.bseindia.com/corporates/anndet_new.aspx?newsid=165790da-6a75-4967-99e0-b7cea34388e2

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Find enlcosed link providing details of shareholder return for VST Industries since IPO in 1975. Disclosure are already mentioned in the message.

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Hey Dhiraj,

Wanted to know your opinion about how do you see recent tax increase on cigarettes in budget? Rakshit Ranjan of Marcellus was saying in a recent video that cigarette taxation is cyclical in nature. As government keep increases taxes significantly (>10% YoY) for few years, there is a drop in legal cigarette volume and hence potential revenue loss for government and so government relaxes it a bit (by not increasing tax or increasing modestly), and then the volume to legal market comes back. Do you agree with his opinion?
As you are a long term holder of the company, wanted to know your opinion about how do you see legal cigarette industry in long run. Total tobacco consumption volume does not seem to decrease even after steep hike in taxes and prices. Though legal cigarette has de-grown over long term.

Tobacco Consumption in India (Million Kgs./Percentage Share)

Year Legal Cigarettes Other Tobacco forms* Total*
1981 – 82 86(21%) 320(79%) 406(100%)
2017 – 18 52(9%) 544(91%) 596(100%)
Difference(%) -34(-40%) +224(+70%) +190(+47%)

Reference

As cigarette companies enjoy great pricing power and so even in the trend of declining volume, they can keep increasing price and hence can enjoy sustained profitability. How do you see price in-elasticity of cigarette products? At what price hike, you would consider the elasticity to start occurring?

I found This study interesting which takes into account, inflation and rising income level, to compare nominal price increase of cigarettes and affordability. They have shown that even though there have been nominal price increase, but if adjusted for inflation and rising income level, Cigarettes and Bidis have become more affordable since 2000. If this study is believed to be true, and legal cigarette volume is declining, then Bidi and illegal cigarette volume must have grown (due to more affordability and net increase in tobacco consumption).

Thinking hypothetically, Does it make for a case that if the rationality to really control tobacco consumption comes, and tax arbitrage between other tobacco products and legal cigarettes comes down, there might have a net shift from other form of tobacco consumption to cigarettes?