ITC Underperformance Analysis
ITC is a major Indian global conglomerate based in Kolkata, West Bengal. Upon establishment in 1910, it was called as the Imperial Tobacco Company and later in 1970, renamed as the Indian Tobacco Company. They were finally renamed in 1974 to ITC.
ITC has too many irons in the fire meaning, they are quite diversified in their business. They initially started off just being a tobacco producer but then they later dipped their toes in packaging and printing business, which is currently India’s most sophisticated packaging house.
They entered into the hospitality industry later in 1974 and they utilised this business as their money-making machine as well as providing employment and creating tourism infrastructure. In the subsequent years, ITC kept growing their hospitality business.
The early 2000s saw a huge diversification round and they dipped their toes into many consumer-centric industries. ITC entered the FMCG market with the launch of their mint o and Candyman confectionery and Ashirwad Atta in 2002. And they entered the education products market also during this period with their brand ‘Papercraft’.
They subsequently also entered the lifestyle retailing business with their brand ‘Wills Lifestyle’ for their relaxed wear for men and women.
Since then ITC hasn’t looked back, they have kept diversifying and growing their multiple subsidiaries.
ITC MANAGEMENT
The company’s corporate governance processes are intended to help the management of their various business while maintaining focus on each one of them. Their decision making takes place at three levels i.e. Strategic Supervision by the Board of Directors, Strategic Management by the Corporate Management Committee and Executive Management by the Divisional Business Unit Directors.
INDUSTRY
India being a developing country translates into it having better job opportunities, offering better salaries, giving higher disposable income in the hands of the working population, which they spend on improving their quality of life and standard of living. The large chunk of the Indian population is between the age of 15 and 64, and they like to spend a significant part of their income on food and clothing. This provides great opportunities for the companies involved in the FMCG industry like ITC. It enjoys more than 80% market share in the cigarettes segment. A major chunk of their profits come from the cigarette industry. However, this business is burdened by high taxes so they have started shifting their focus on FMCG and processed food business in order to lessen their business risk. This FMCG business brings in 20% of their net revenue followed by their Agri business which brings in 19% of their revenue and the stationery and packaging business brings in 11.5% of their revenue.
ITC VS COMPETITORS
ITC’s direct business competitors in the FMCG industry are HUL and Nestle and in the Cigarette Industry, it has Godfrey Phillips and VST Industries as competitors.
From December 2018 ITC has witnessed a 24% drop in their market share meanwhile HUL gained 24% market share. Nestle has also increased its market share by almost 52%.
Investors have shunned ITC and have started flocking to HUL.
The answer to why investors are keeping a distance from ITC lies in the steep competition it is facing from the Tobacco Industry. VST Industries and Godfrey Phillips have been following aggressive expansion strategies and that is affecting ITC’s tobacco business. To top it all off the government of India imposes heavy taxes which further damages the profits. The environment conditions also have not been favourable for ITC. The Covid19 pandemic also came as bad news for ITC.
HUL has been taking advantage of this situation and has been furthering their business and market position. They have been posting steady numbers and have also been reporting heavy market expansion. This can be considered as a classic example of market leaders further strengthening their position during challenging economic phases.
All the above-mentioned reasons are why ITC is facing immense pressure to reduce its dependence on its tobacco business and focus more on its FMCG business and its hospitality business.
Coming to its peers in the cigarette business, ITC stocks have seen a decline of almost 28%, whereas its peer stocks – VST Industries and Godfrey Phillips India Ltd have soared by around 27% and 30% respectively. Despite this fall ITC has still managed to maintain its market capitalisation.
Ever since budget 2020 came out, ITC is likely to witness lower profits since the effective tax rates saw a rise of 10% -13% with the cigarette business being ITC’s cash cow and bringing in 85% of its net profits. It majorly derives revenue for ITC with the FMCG and Hospitality coming next in line as revenue generators for ITC.
ANALYSIS
STOCK PRICE
The current stock price as of today of ITC is ₹181.85. With the current stock price, ITC has taken roughly 10 years to double the money which is a very disappointing performance. The stock has fallen like another company and it’s not even behaving like a defensive stock like at one point it used to be. ITC was a well-known defensive stock and now things have changed over a period of time.
SALES
Last 10 Years the sales have grown at a CAGR of 11% for the year FY2010–2019 from Rs. 18144 crores to Rs 44983 but at the same time as I mentioned above, it’s under tremendous pressure to reduce its dependence on its cigarette business.
The operating profit margin for the last 10 years has been more or less the same without much change at 36% for the last 10 years. This is a positive sign. The earning per share has grown from Rs. 2.56 in FY 2008 to Rs. 12.08 TTM 2019. While the earning was growing at a steady pace their valuations got strained from the year 2013–17 the PE ratio was ranging from 40 - 49.
Despite the low public consumption due to the slowdown, ITC has seen a 29% increase in sales from the last year.
DIVIDENDS
The company has been consistently providing dividends from the year 2003. In the year 2000, the price of the stock was around Rs. 20 if one had purchased in the year 2000 and kept it to date apart from price appreciation the stock has given dividends to the tune of Rs. 150 in the last 20 years.
Even if these dividends were reinvested in the stock then the returns would have been much higher. And the consolidation of few years should hardly matter to a long-term investor.
PRICE TO EARNING RATIO
The PE ratio of these 3 companies is also in a similar range. PE ratio of ITC Ltd is 15.45, while PE Ratio of VST Industries Ltd and Godfrey Phillips India Ltd is 18.4 and 15.11.
Despite pulling a major chunk of profit from its tobacco business, ITC presently employs much greater capital in its other businesses like the FMCG, Hospitality Packaging, Paperboards & Specialty Papers.
Whereas, its competitors VST Industries and Godfrey Phillips India Ltd both are wholly involved in their respective tobacco businesses.
CONCLUSION
The tax hikes have only been a recent contributor to ITC’s subpar performance, but they are not the only reason for ITC’s underperformance. The tax regulations have been consistent for the past two years. In addition to these steep regulations, the environment for smoking was not good even before the government rolled out National Calamity Contingent Duty (NCCD) in its budget in 2020. According to Euromonitor data, the global number of smokers has decreased since the past decade. The regulations are only about to get stricter for the tobacco industry after this National Calamity Contingent Duty (NCCD) since it gives the government one more opportunity to hike duties. Therefore, the investors who are looking for the cigarette environment to change anytime soon have got it wrong as all the points I mentioned above point to the cigarette industry facing a lot of external environmental pressure.
ITC had been underperforming even before these tax regulations were rolled out.
However, ITC saw these hike in taxes as an opportunity to increase the price of their cigarettes and therefore increasing their revenue from the pricier cigarettes.
ITC went through a change in leadership in 2017. The change of leadership has also not made a positive change in the prices of ITC. Since the appointment of the current CEO, Mr Sanjiv Puri, the stocks have only seen a reduction in their value. A lot of peers of ITC also underwent a change in leadership appointing outsiders as CEO which then resulted in improvement of performance; however, the situation was not the same in the case of ITC.
The investors will only seem to return back to ITC once they see a growth in the company. The profits of their tobacco business lately seem to be under pressure but they are not the only reason of worry for the company. The leadership needs to make a turn in their subpar performance in order for them to get back investor confidence.
The global environmental scenario doesn’t seem to be changing anytime soon therefore ITC needs its management to step up the performance of various other businesses.
The pandemic also caused a huge loss to its hospitality business with a complete fall in tourism.
The only solution with ITC right now is to divert their focus from the tobacco business to their other businesses i.e. FMCG, Hospitality Packaging, Paperboards & Specialty Papers.
In recent years, a lot of young woke investors have started putting their money in environmentally and socially conscious investments. A lot of brokers have also followed suit and started offering financial products based on these values. This rise in sustainable investing has come as bad news for ITC. It has failed to attract these socially conscious FIIs. A lot of FIIs have been pulling away from ITC since their sustainable business practices (being water positive, carbon positive and solid waste recycling positive) have failed to win over its ESG-conscious investors. From 20% in December 2017, the FII holding has decreased to about 15% at the end of December 2019.
ITC needs to step up their sustainable business practices if it wants to attract these environmentally conscious investors. Opting for environmentally safer business practices will help their case.
Another contributing reason for the underperformance of ITC is due to the poor performance of its non- tobacco businesses. ITCs major business operations do not translate their capital into revenues. About 65% of its businesses contribute to only 15% of its profit. Despite being in these non- tobacco businesses for over 20 years, ITC has not been able to harness its potential and has not been performing as well as its peers in the FMCG business. The return on capital has declined despite their profits rising over the years. The company is banking on the FMCG sector to command valuations however they need to do some serious introspection and make significant changes in their strategic management in order for them to pull through major revenue from their FMCG business.
The last major factor in their underperformance can be that they are too diversified. ITC is probably the most diversified business in the stock market. They need to start focussing on their core competencies and move away from the businesses they are not good at. What I mean here is maybe divesting a portion of their business might make them focus better on their major businesses. Divesting will surely help ITC and it will take off some burden off their plate. Divesting will help them move their focus from underperforming or poorly performing business to their main businesses. They can infuse the capital they generate from divesting and utilize it in their core businesses. This will surely translate into better revenues and in turn better profits.
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