ITC ANTI-THESIS

  As an investor who has taken positive stance on ITC for a long time, it pained to see stock doesn’t move as per expectations, on the contrary valuation became compelling every passing quarter.

In this note, we will try to write why ITC is not performing as per investor expectations. An anti-thesis on ITC to gauge if stock can make turn for better in foreseeable future.

1.      Why ITC despite being formidable cigarette biz trades so low in valuation compared to its FMCG peers: Let’s keep HUL/Nestle out of peer comparison for ITC. MNCs command v different kind of valuation multiple compared to Indian counterparts. However, ITC trades much lower valuation even when compared to Dabur/Marico/GodrejCP (40-50x PER vs ITC sub-20x). When Marico, Dabur & GodrejCP trades at 40-50x, company operates in free market decision making environment of how much price they can charge to customers and what would be their growth look like.

At ITC, growth which accrue to shareholder has been lower compared to what been taken by government in the form of taxes. When shareholder knew company will always take far lower share of profit compared to its potential from future then it should also trade at lower multiple. Consistent increase in taxes and everytime fiscal situation gets worsen, clamour to milk cigarette companies further has made ITC looks like PSU to investors, which will be given only as much oxygen which keeps it alive, rather than becoming stronger with time. 

What might change investor negative perception trickling from Govt. on ITC: Some indication that progressively taxation will not be punitive in nature. Govt. will increase taxes which are near inflation and hence company can grow as per its potential and shareholder gets visibility to benefit from the growth of the company. Since, no government will take such politically unwanted step, ITC investor has to be endure the step-motherly treatment.

However, we don’t understand, government also treat alcohol company in similar way as Cigarette, but United Spirits/United breweries trades at much higher multiple compared to ITC. May be, here the difference comes from being MNC vs ITC with 30% BAT stake is considered domestic conglomerate. 

2.      FII remain constant seller due to ESG concern: This has been confirmed from shareholding data as well. FIIs stake has been reduced from 19.1% to 14.6%. 

But then if one look at Philip Morris, it seems 75% is held by institutions and AMC, then why the FIIs are vacating Indian cigarette manufacturer.

However, point to note that, Philip M and BAT has given up significant value in last 5yr (about 25-30% lower) hence there is global value destruction in the cigarette biz.

FIIs should see Indian market different from developed market, we have growing youth population, improving income level which further improves cigarette affordability.

May be, they see the potential for cigarette consumption will not fructify due to Indian govt and FIIs are hanging up on ITC.

3.      Despite scaling to 3^rd largest Non-Cigarette FMCG, valuation lag its peers : ITC has achieved revenue of 12,844cr revenue in FY20 higher than Nestle and Dabur, it’s FMCG biz is still valued far lower compared to peers.

More than 1/3^rd ITC FMCG revenue comes from Asirwad brand, which is low margin/RoCE product. Hence, despite scaling to may be 4000cr revenue its contribution to EBITDA remain far lower.

Brands which can become competitive among peers in terms EBITDA margin & RoCE, Sunfeast, Bingo, Yippee, once they start contributing higher sales in the overall pie, will lead to overall margin improvement for ITC.

Ideal way to value FMCG business of ITC might be to value it as EV/EBIT instead of valuing it on EV to sales, with multiple which are comparable to Dabur/Marico. Then we will have EV/EBIT multiple of 20-25x and bring down valuation of the segment down to 20,000cr instead of 60-70,000cr when we value it as EV/sales

4.      Remaining Hotel/Paper/Agri doesn’t contribute more than 5% of the overall valuation, hence doing any holding company kind of discount in ITC would be wrong. In other words, markets try to destroy value of cigarette and FMCG business as a means of holdco discount, with a view that management focus is misdirected.

Let’s leave the other parts valuation depressed as other papers and hotel companies are trading in the market, rather than holdco discount.

After all the thought, if we try to put a number on the valuation, it seems market is valuing the company with the following multiples to arrive at the price at which it is trading right now.

Segment	Year	Metric	Value	Multiple	EV	Value per share
Cigarette	FY22	EV/EBIT	16,803	10	1,68,025	137
Non Cigarette FMCG	FY22	EV/EBIT	782	15	11,729	10
Hotel	FY20	Assets Value	7,563	0.5	3,782	3
Paper	FY22	EV/EBIT	1,258	3	3,774	3
Agri	FY22	EV/EBIT	870	3	2,611	2
Total					1,89,921	155
Cash & Eq (FY20)					25,000	20
Fair Value					2,14,921	176

 

Disclosure: Remain invested