ITC Stock 7 Point Analysis
ITC has been a very interesting stock lately. It’s Q3 revenues and profit beat street expectations even amid economic slowdown and its net profit went up by 30%.
But in spite of that, the shares of ITC are under heavy selling pressure and people are wondering what exactly is going on with ITC?
In this article we will do a short, crisp 7-point analysis of what’s going on with 100-year-old company. ITC.
So, let’s get going.
1. ITC has a heavy dependency on cigarette business
This is something people don’t realize…people think of ITC as a conglomerate.
When you look at their earning statement, they look like a very well diversified company.
In terms of revenue, their cigarette business contributes about 40% to the revenue. FMCG contributes about 25%, Agri Business about 16%, Paper Board, Packing and Paper about 12% and Hotels about 4%.
So, the revenues look well diversified, right?
But if you look closer, the real business driver is the cigarette business.
What do I mean? Well, let’s take a look at the EBIT, which is the contribution towards the profitability.
Cigarettes contributes about 85% of the profits and the rest of the segments combined only contribute to 15%. In other words, out of every 100 rupees of profit, cigarette gives 85 rupees.
Just like the word “tobacco” is right in the company’s name, the business of tobacco is also the right at the heart of ITC.
What that essentially means is that any adverse impact on the cigarette segment directly hits its bottom-line.
2. High Government Duty
That brings us to the #2, which is the government’s constant effort to use these sin products as cash cows. Recently Finance Minister, Ms. Sitharaman increased the National Calamity Contingent Duty (NCCD) on cigarettes anywhere between 200-400%.
It is such an easy target when you have to choose increasing GST on something like cars vs. something like cigarettes- of course you will choose cigarettes. They get the revenue that they so desperately want and they also get to take a moral stance that look “we are making cigarettes more unaffordable”. I don’t buy the 2nd argument because everyone knows that cigarette consumer is either going to pay higher or maybe go for the illegal cigarettes.
3. Competitors are not playing by the same rules
The trouble for ITC is not just the self-righteous government. They are also being screwed by the illegal market.
India has become the 4th largest and the fastest growing illegal cigarette market in the world. one out of every 4 cigarettes are either smuggled or counterfeit from countries such United Arab Emirates, Bangladesh, Indonesia and China and even Nepal.
Why are they so popular?
Well, the most obvious reason is that they don’t have to pay any GST, any custom duty or any tax. It’s much cheaper for a consumer to buy a smuggled
The second reason is that Indian government has mandated that every cigarette box will have at least 85% of the surface should have warning labels indicating the harmful effects of. So, the consumers something thing, hmm, if I smoke this brand, I may get cancel but this one doesn’t say anything about cancer so maybe this is better. The sale of legal cigarettes has gone down by 4% whereas that of illegal cigarettes have gone up by 5%
So, these illegal players are not playing by the rules and hence bleeding the profits away from ITC.
4. Technical problem with ITC
It is owned by several mutual funds and it seems that these funds have gotten sick and tired of being at the mercy of government for making a decent return. Especially given that this government has 4 more years to go.
And what seems to be happening is that the money is shifting from ITC to other companies such as Hindustan Unilever.
5. What is ITC doing about it?
The management is very knowledgeable. They know that the government is unlikely to do anything about the illegal cigarettes and they also know that they will have to keep paying higher and higher taxes. and with more and more urban population understanding about the perils of cig., the long-term trend of cigarettes is downside.
SO, they are doing that any smart management would do. They have been aggressively diversifying. And here is what you need to understand because what the management is doing is fixing the problem in the long term rather than looking at the short term profitability.
See, we have talked about how cigarette companies are at such a negative positioning but in spite of all that, why is that the competitors of ITC, Godfre P & VST industries are up 30-50% last 12 months whereas ITC is down?
The reason is that ITC is making a choice of investing their profits in other lines of business – businesses such as FMCG, Hotels, Agri etc, which may not have the same ROI as that of cigarettes today but once these brands have been established, they will take the dependency away from the cigarette business and that in my opinion is very very smart.
It takes guts to say that knowing that I will take these 1000 crores and put that in a business which will give me only 1/10th of the return .
6. Fundamentally strong company
- Great household brands (Ashirwad atta, Sunfeast biscuits, Bingo, Yipee, Mangaldeep, classmate)
- Vast distribution network
- Very experienced management
- Vertical integration of supply chain – more profitability
- Addictive product, which has inelastic demand. They can keep increasing the prices and those who consume would just suck up and pay more. they don’t have many choices.
7. Will I buy?
I will not. Some due to ethical reasons but also this overhang of government regulation will never go away. It will keep coming back. It may be a value buy for some investors at this price but it is not going to become a multibagger just on the cigarettes business.
But the silver lining in all this is that the management is serious about reducing its dependence on cigarettes and are building some really strong brands. Building these brands may take time and initially, they may not be great ROI providers but once they are well established, life will become easier.
And hopefully, at some point, if the revenue mix becomes more homogeneous, the stock will see a rerating. But up until then, the stock will find value buyers hunting for low P/E ratios but as soon as there is a rally, some other government tax hike would spoil the party.
Also, if the Government wants to keep this cash cow alive, they need to stop taxing ITC to death; instead, they should take some action on the illegal players in India because not only they are not paying their fare share of taxes but also they are providing more harmful, untested products in the market.
We will make another, more comprehensive review on ITC because there is so much to learn and analyse about this company.
Let us know in the comments below if you would like to make such a review. And we spend a lot of time and effort in making these analysis, so if learned something or found something useful, please share with your friends.
ITC has been a very interesting stock lately. It’s Q3 revenues and profit beat street expectations even amid economic slowdown and its net profit went up by 30%.
But in spite of that, the shares of ITC are under heavy selling pressure and people are wondering what exactly is going on with ITC?
In this article we will do a short, crisp 7-point analysis of what’s going on with 100-year-old company. ITC.
So, let’s get going.
1. ITC has a heavy dependency on cigarette business
This is something people don’t realize…people think of ITC as a conglomerate.
When you look at their earning statement, they look like a very well diversified company.
In terms of revenue, their cigarette business contributes about 40% to the revenue. FMCG contributes about 25%, Agri Business about 16%, Paper Board, Packing and Paper about 12% and Hotels about 4%.
So, the revenues look well diversified, right?
But if you look closer, the real business driver is the cigarette business.
What do I mean? Well, let’s take a look at the EBIT, which is the contribution towards the profitability.
Cigarettes contributes about 85% of the profits and the rest of the segments combined only contribute to 15%. In other words, out of every 100 rupees of profit, cigarette gives 85 rupees.
Just like the word “tobacco” is right in the company’s name, the business of tobacco is also the right at the heart of ITC.
What that essentially means is that any adverse impact on the cigarette segment directly hits its bottom-line.
2. High Government Duty
That brings us to the #2, which is the government’s constant effort to use these sin products as cash cows. Recently Finance Minister, Ms. Sitharaman increased the National Calamity Contingent Duty (NCCD) on cigarettes anywhere between 200-400%.
It is such an easy target when you have to choose increasing GST on something like cars vs. something like cigarettes- of course you will choose cigarettes. They get the revenue that they so desperately want and they also get to take a moral stance that look “we are making cigarettes more unaffordable”. I don’t buy the 2nd argument because everyone knows that cigarette consumer is either going to pay higher or maybe go for the illegal cigarettes.
3. Competitors are not playing by the same rules
The trouble for ITC is not just the self-righteous government. They are also being screwed by the illegal market.
India has become the 4th largest and the fastest growing illegal cigarette market in the world. one out of every 4 cigarettes are either smuggled or counterfeit from countries such United Arab Emirates, Bangladesh, Indonesia and China and even Nepal.
Why are they so popular?
Well, the most obvious reason is that they don’t have to pay any GST, any custom duty or any tax. It’s much cheaper for a consumer to buy a smuggled
The second reason is that Indian government has mandated that every cigarette box will have at least 85% of the surface should have warning labels indicating the harmful effects of. So, the consumers something thing, hmm, if I smoke this brand, I may get cancel but this one doesn’t say anything about cancer so maybe this is better. The sale of legal cigarettes has gone down by 4% whereas that of illegal cigarettes have gone up by 5%
So, these illegal players are not playing by the rules and hence bleeding the profits away from ITC.
4. Technical problem with ITC
It is owned by several mutual funds and it seems that these funds have gotten sick and tired of being at the mercy of government for making a decent return. Especially given that this government has 4 more years to go.
And what seems to be happening is that the money is shifting from ITC to other companies such as Hindustan Unilever.
5. What is ITC doing about it?
The management is very knowledgeable. They know that the government is unlikely to do anything about the illegal cigarettes and they also know that they will have to keep paying higher and higher taxes. and with more and more urban population understanding about the perils of cig., the long-term trend of cigarettes is downside.
SO, they are doing that any smart management would do. They have been aggressively diversifying. And here is what you need to understand because what the management is doing is fixing the problem in the long term rather than looking at the short term profitability.
See, we have talked about how cigarette companies are at such a negative positioning but in spite of all that, why is that the competitors of ITC, Godfre P & VST industries are up 30-50% last 12 months whereas ITC is down?
The reason is that ITC is making a choice of investing their profits in other lines of business – businesses such as FMCG, Hotels, Agri etc, which may not have the same ROI as that of cigarettes today but once these brands have been established, they will take the dependency away from the cigarette business and that in my opinion is very very smart.
It takes guts to say that knowing that I will take these 1000 crores and put that in a business which will give me only 1/10th of the return .
6. Fundamentally strong company
- Great household brands (Ashirwad atta, Sunfeast biscuits, Bingo, Yipee, Mangaldeep, classmate)
- Vast distribution network
- Very experienced management
- Vertical integration of supply chain – more profitability
- Addictive product, which has inelastic demand. They can keep increasing the prices and those who consume would just suck up and pay more. they don’t have many choices.
7. Will I buy?
I will not. Some due to ethical reasons but also this overhang of government regulation will never go away. It will keep coming back. It may be a value buy for some investors at this price but it is not going to become a multibagger just on the cigarettes business.
But the silver lining in all this is that the management is serious about reducing its dependence on cigarettes and are building some really strong brands. Building these brands may take time and initially, they may not be great ROI providers but once they are well established, life will become easier.
And hopefully, at some point, if the revenue mix becomes more homogeneous, the stock will see a rerating. But up until then, the stock will find value buyers hunting for low P/E ratios but as soon as there is a rally, some other government tax hike would spoil the party.
Also, if the Government wants to keep this cash cow alive, they need to stop taxing ITC to death; instead, they should take some action on the illegal players in India because not only they are not paying their fare share of taxes but also they are providing more harmful, untested products in the market.
We will make another, more comprehensive review on ITC because there is so much to learn and analyse about this company.
Let us know in the comments below if you would like to make such a review. And we spend a lot of time and effort in making these analysis, so if learned something or found something useful, please share with your friends.
Please do keep following up.
It is advisable to put a date on the research. Because all such information is valid only for a particular time frame,
It was a nice analysis.
Very good explanation and research. However, as shri vikas kashikar has rightly said, the research date is must as these information may be time bound. Thank you.
Simple, sensible, perfect review.
cigarette business contributes 85 % to profits, is this ratio decreasing over a period of time? Or increasing?