Valuation gains from non-cigarette businesses likely for ITC's investors

Topics ITC Ltd | ITC cigarette

Stock valuation represented by price-to-earnings multiple of ITC has always remained below some of the major fast-moving consumer goods (FMCG) players, thanks to the company’s excessive dependence on cigarette business, which is highly exposed to regulatory changes. 

However, the company’s increasing focus on non-cigarette business, tilting more towards other-FMCG segment (includes packaged food brands such as Bingo!, Aashirvaad, YiPPee!, Sunfeast, Classmate [education segment], Fiama, and Savlon [personal care], among others), is expected to fuel valuation of ITC. 

According to analysts at Edelweiss Securities, the valuation difference should narrow as ITC scales up its FMCG business.

ITC’s 2018-19 (FY19) annual report indicates its increasing thrust on non-cigarette businesses. From 48 per cent in 2017-18, revenue share of ITC’s non-cigarette businesses drifted up to 54 per cent in FY19, with revenue growth of 16.4 per cent on a standalone basis. This was mainly driven by other-FMCG business, which includes branded packaged foods (staples, snacks and meals, dairy and beverages, confections), education and stationery products, personal care, etc. Non-cigarette business includes hotels, paper, and agri, besides the other-FMCG segment.

Other-FMCG business clocked 10.4 per cent growth in revenue in FY19 to Rs 12,535 crore, ahead of the industry, even as sales got restricted due to liquidity crunch and consumption slowdown later during the second half of the financial year. 

The business also supported ITC’s overall top line growth in FY19, despite a 9.5 per cent fall in its flagship cigarette business that alone accounted for over 45 per cent of standalone revenue and almost 85 per cent of profits, based on the segment data. A strong pipeline of new launches (over 50 in FY19) and relatively more investments are expected to propel the other-FMCG business of ITC. 

Of the total capital expenditure of Rs 2,444 crore (excluding the unallocated portion) in FY19, 54 per cent was towards the other-FMCG business, followed by hotels (27 per cent). ITC commissioned a consumer goods manufacturing and logistics facility in Tamil Nadu and ramped up production of its other units in Punjab, West Bengal, and Assam. These investments should start yielding results once the consumption demand recovers with expected normal monsoon. 

In fact, key brands of ITC’s other-FMCG business have witnessed strong growth over the past two years, indicating rising customer preferences. The brand size of Aashirvaad, Sunfeast, and Bingo! registered a compound annual growth rate of 12-58 per cent between 2016-17 and FY19 to Rs 4,500 crore, Rs 3,800 crore, and Rs 2,500 crore, respectively. 

Some analysts say ITC has already secured strong brand position in flour (Aashirvaad), instant noodles (YiPPee!), and biscuit (Sunfeast) categories.

What would further support the other-FMCG business of ITC is a strong distribution network. According to the annual report, ITC has over 6 million outlets directly or indirectly across various trade channels.

Apart from other-FMCG, its hotels, agri, and paper (paperboards, paper and packing) businesses are also likely to gain traction, thereby further diversifying ITC’s business.

Though expected price increase could support overall revenues from cigarette business, long-term growth of the segment remains under question, given the regulatory pressures and higher share of chewing tobacco in India, say analysts.

Going ahead, higher operating profit share and strong profitability of other-FMCG business would be key to a sharp valuation improvement.

According to Nitin Gupta, analyst at SBICAP Securities, “Though the top line of ITC’s other-FMCG business could grow 200-300 basis points (bps) ahead of other FMCG majors, ITC’s profitability dependence on cigarette would still remain significant. This would restrict the valuation benefits for ITC.”

Yet, raw material sourcing benefits through its agri business and low-cost packaging from its paper business would continue to aid the overall margin of ITC. Analysts foresee a 40-43 bps expansion in earnings before interest, tax, depreciation, and amortisation margin in FY20 and FY21 to 38-39 per cent. Its earnings would rise by 10-12 per cent annually over FY19-21.

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