A large company with its stock price pinned down; You either love it or you hate it, there is nothing in between. Any guess? Of course, ITC . But what is plaguing the giant?
Before we dive into that, here’s an icebreaker …
Formerly known as the Indian Tobacco Company, ITC is undoubtedly one of the bluest Blue Chip stocks in India. With its century-old legacy, the giant has come a long way to become the largest cigarette company in India . His diversified, professionally managed business, based in Kolkata, generates billions of dollars in profit each year and racks up a massive amount of cash. The dividend-paying company, with its indestructible moat and robust distribution network of six million outlets, is unfathomable!
Despite all this, ITC hasn’t exactly been on the good books of investors in recent years. See for yourself –
As you can clearly see, two of ITC’s closest peers, the VST (in Tobacco) and HUL (in FMCG) industries, have posted a 5-year CAGR in their share price of over 15% and the Sensex has registered a CAGR of 10% in the same period. But ITC?
A measly -3.1% ! Yes, that is really true. And trust us, you don’t have to be an investor to know this; Just scroll down your social media feed and the countless number of memes will tell you everything!
So why is such a cash-rich giant currently meme stuff? Why is ITC’s share price pretty doomed? Why do you generate mixed opinions? Well, read on to understand.
ITC’s addiction to cigarettes
Tobacco is ITC’s raison d’être. Sure it makes sense. You see, according to the 2017 GATS survey, one in four Indian adults uses tobacco almost daily! That’s a big market for the monopoly giant to take. With over 80% market share in the Indian cigarette industry, ITC products such as Gold Flake and Classic have become a smoker’s favorite.
Consequently: ITC’s cigarette segment, which requires only one-tenth of the total capital employed in its business, generates almost half of the company’s revenue and accounts for a whopping 85% of its profits .
Therefore, ITC has good reason to take advantage of this light asset business. But it’s not so rosy!
Tobacco is considered a ” product of sin .” You cannot advertise it openly. You cannot package it the way you want. People will disapprove of you for turning their relatives into cigarette addicts. Investors who pay close attention to ESG (environmental, social and governance) metrics will not endorse it. And above all, there will be uncertainty regarding the regulations.
While this is really problematic, big players like ITC, with their strong distribution network, sell their products even without much publicity. Additionally, ITC has a stellar ESG rating of ‘AA’ according to MSCI. Their ESG score outperforms Dabur , Britannia, RIL and Coal India! Even then, what is the problem, you ask?
“When they need it, smokers have to pay” – a single line that describes the whole problem. In fact, the government can levy as much tax as it can on these ‘products of sin’, all in the name of the public interest. And this is evident as the annual tax revenue collected from cigarettes has more than doubled in just a decade!
While ITC can pass the tax burden on to picky customers, pushing them too hard will make them change (considering the fact that India’s legal cigarette market is only ~ 20% of the entire tobacco industry). And that can affect ITC’s results!
Furthermore, the legal consumption of cigarettes in India is steadily declining.
So it makes sense for ITC to diversify, doesn’t it? After six decades as a pure cigarette company, ITC decided to do it in the 1970s. Since then, it has been using its cigarette segment, a source of income, to finance its diversification plans and shed its “bad boy” image. “to become a” har ghar ka “product. It seems that ITC wants to reduce your addiction to cigarettes.
Some of their diversification plans have worked quite well. The Agri -segment generates a return of 27% on the capital employed. It has the ‘e- Chaupal ‘ program, the largest rural digital infrastructure in the world, which provides Internet access to more than four million farmers and is prepared to benefit from the new agricultural laws in force.
ITC is also the market leader in its Paper and Packaging segment , which generates a 21% return on capital employed.
However, the company has attracted attention due to two of its crucial diversification plans: consumer goods and hotels .
A cigarette company in the consumer goods business
In the mid-2000s, ITC made a bold entry into the consumer goods market, challenging incumbents, some of whom existed even when Gandhiji was doing his first legal practice. ITC had taken on companies like HUL and P&G on personal care products, Britannia and Parle on cookies, and Nestlé on instant noodles.
Fast forward a decade, and ITC has already built 25 vibrant parent brands (plus a few complementary acquisitions), each of which is a leader in its category. Aashirvaad is the number one wheat flour in the country. Sunfeast leads the premium cookie market. Yippee & Bingo are next door to Nestlé’s Maggi and PepsiCo’s Lay’s.
Savlon (an antiseptic liquid soap) is considered the best of all its good acquisitions. The sales Savlon of Rs 1000 Crore in 2020 are amazing four times the price paid for it and ITC 16 times sales during its acquisition. That is precisely an incredible 50% CAGR !
In a matter of just fifteen years, ITC’s consumer goods revenue soared almost thirty times to Rs 13,000 Crores in 2020 !
However, profitability in its consumer goods segment has been a major concern for ITC.
You’d be surprised to know that …
The segment assets of consumption of ITC , which accounts for almost a quarter of their income (26%) Contribute only 2% of its benefits !
While its consumer goods peers have a 15-20% profit margin, ITC’s margin is only 2%! Why is this so, you ask?
The simple reason behind this is that ITC’s consumer goods brands are relatively much younger. While companies like Britannia has been in business since the time of Gandhiji, the ITC dabbled in consumer goods much more later, only in the 2000s.
And you should know a little about the consumer goods industry that it takes a lot of time and exercise to burn cash to become a household name. You have to run large-scale promotional campaigns, advertise extensively, and capture your competitors’ market by attracting customers with aggressive pricing and deep discounts. Therefore, being a late entrant, ITC has been incurring huge costs for all of this, which is why its profit margins in the consumer goods segment are quite low.
To some extent, it is also due to the fact that ITC, unlike its peers, has turned to organic growth by building most of its brands from scratch with just a few acquisitions, and such a growth strategy requires more capacity to suffer initially. . So there you are.
All in all, ITC remains a cigarette company trying its hand in the consumer goods sector.
ITC luxury hotels: ‘a terrible mistake’
ITC Hotels is the second largest hotel chain in India , with more than 100 establishments spread across the country. However, as the name implies, luxury hotels cater only to a small group of big pockets and are a very seasonal business. Even when the hotel is unoccupied, the company has to spend a lot of money on various fixed costs, salaries, and other maintenance charges, which are a must for such luxurious hotels.
Implicitly, ITC has to spend a lot of cash to keep its hotels running. And if he’s doing it, hotels must be a very lucrative business for him, right? ITC must generate a lot of revenue and profits from the hotels, huh? Well, NO.
While ITC invests 24% of the total money invested in the business in its hotel segment, that contributes only a meager 1% to its profits!
With ITC burning huge amounts of cash for its hotel segment, which is nothing more than a losing game, this will be a classic case study of how NOT to allocate capital in a company.
Why is ITC’s share price stagnant?
By now, you must have the most reasons to justify ITC’s stock price stagnation. But that is not all!
With a whopping 25,000 million of rupees in cash on its balance sheet, ITC is trapped between the sword and the wall . Even after distributing 85% of your earnings as dividends, you have ended up putting the money in the wrong places (for example, hotel businesses). Therefore, investors are not sure what to do with his huge amount of cash.
Part of the problem can also be attributed to ITC’s ownership structure. There are no promoters, conflicts between investors (MTD and GOI) and an abundance of supply of their shares in the market.
But above all, the business structure of ITC is quite complicated, which makes it difficult to discover value . One company generates a lot of cash but has regulatory uncertainty (Cigarettes), the other uses cash to generate income but less profit (FMCG) and another burns a lot of cash for almost nothing good (Hotels). Therefore, investors simply do not know what metrics to judge the ITC.
So, don’t you think it makes sense for ITC to divide its business into parts so that investors can better value them individually?
In short, should the ITC disband?
The bottom line
While it could be a perfect case for ITC to part ways, it is rumored to be highly unlikely. Instead, a revamp of your hotel business could be at stake. They are looking for ‘alternative’ ways of managing hotels, probably through deals rather than ownership.
If you ask us, we believe it is entirely the responsibility of management. You must decide whether the company as a whole is really better than the sum of its parts. And if not, better to separate.