ITC Ltd – Is it Worth Investing?

Business Introduction:

The established multinational conglomerate company is headquartered in Kolkata, India at the “Virginia House building”. Until the 1970s, the company was known as ‘Imperial Tobacco Company’ later renamed as ‘Indian Tobacco Company’ and then in 1974, to ‘I.T.C Ltd’. By the end of 2001, the company was renamed (by removing the ‘full stops’) as “ITC limited”.

A diversified Conglomerate FMCG company with business products in Foods, Personal Care, Cigarettes and Cigars, Branded Apparel, Education & Stationery Products, Incense Sticks and Safety Matches; Hotels, Paperboards and Packaging, Agri-Business and Information Technology, and many more.

Today, ITC is amongst the top FMCG companies in India ranking at No.3. ITC Ltd has a market cap of over Rs.2.5 lakh crores. With an expertise of over a century and a deep understanding of the Indian consumer mindset. The Company has garnered the majority of market share through its various product lines. 

Who is the owner of ITC Limited?

Although there is no one promoter group to ITC limited. The ownership is diluted amongst many large Fund houses and Institutional investors who find value in the company. Amongst many, the top shareholders in the company (other than Directors, Promoters and Holders of GDRs and ADRs) are as follows:

British American Tobacco (BAT) is the single largest shareholder in ITC limited withholdings at 29.7% of the company.

ITC Shareholder list:

ITC Segment wise explanation:

ITC is a conglomerate company with 4 notable segments and multiple streams of revenue. Now, let’s check out the business segments individually.

Cigarette Business:

This is the business that sustains ITC’s market value. The cigarette business earns over 40% of the company’s entire gross revenue and this gem provides a return on invested capital of almost 400% and at an operating margin of 70%. 

The cigarette business is a sheer “cash cow” that feeds the expenses of ITC’s other businesses. Over the years, we have noticed the cigarette business gradually reducing. Hence, the company must earn stable revenue from its other sources, mainly FMCG.

FMCG Business:

When we talk about “ITC” we want the company FMCG segment and nothing else. So, here are the top-performing ITC brands.

FMCG segment product:

With just a 5.09% return on invested capital and an operating margin of roughly 3%, the FMCG company has notably underperformed despite growth in brand portfolio and sales figures.

When we invest in any business and it gives a return under the inflation rate, we are not making any real growth! But, if the said business is such that the business has scope (huge market growth potential). Then, by all means necessary, the management should do whatever it takes to grasp the market share. 

Because of high market share and an acceptable product portfolio. The company gets to command the price to a comfortable level and consumers will buy. A sales level in numbers, a margin to be reached by the company, post which, the company can make a healthy profit.

Hotel Industries:

ITC has 107 hotels in over 70 locations. And, the Hotel Industry is probably the worst performer in the conglomerate chain. With a return of invested capital of under 3%. This segment has performed awfully over the years. 

But, the Hotel industry in itself is a low-margin business at least the case in the initial years of its operation. The market should accept and only then, we can see some good numbers. And, with the covid pandemic, the entire chain of business has seen its revenue drop to 1/3rd the usual case due to lockdown and aftermath. 

Also, the hotel industry has a good entry barrier. So, the ones with established location and hotel bases will be able to monetize well in the coming years. It’s a waiting game for now.

A word from Mr.Sanjiv Puri on ITC hotels:

Mr. Sanjiv Puri (ITC chairman) says – “The management is not ruling out the possibility of restructuring different businesses, including demerger of hotels and even listing of ITC Infotech, a subsidiary of the conglomerate business.” Although the management thinks that this isn’t the right time for demerger considering the situation. But, the plan to restructure is not off the table.

Agri-Business:

This is my favorite segment after the FMCG. Why? I see the Indian agriculture sector change from “agriculture as a source of income” to “agriculture as a Business”. Hereon, we get to see India’s large consumer goods-producing entities venture into the Agriculture sector more aggressively. And, this will have two immediate benefits;

1. Agri Business by such entities will produce those goods that are in demand in the market. These companies will produce in lump sum, market them, and finally reach it to the end consumer.
2. Economic reality! Dependence on the Agriculture sector will reduce. 

Now, let’s check out the business verticals and how much they contribute to ITC’s business revenue:

Segment Revenue:

Financial Information:

ITC stock performance has severely underperformed until now. But, what about the financial aspects? 

Is ITC a zero-debt company?

As per the Annual Report dated March 2021, the company had a ‘Financial Liability’ (Non-current) of Rs. 496.04 crore and about Rs. 10,689.68 crore as in Current liability. Put together and other expenses (excluding provisions), the company has a liability of about Rs.12,937.65 crore. And the companies Cash & Equivalents, Bank balance and Current investments at Rs. 19,505.35 crore. Hence, I could see that the company is financially well secured.

[A current liability is a such liability that’s supposed to be met within 12 months and non-current liability would be a liability that’s met over a long-term period].

Also, the reserve of the company. I.e. The General Reserves of Rs. 17,672.57 crore and the Retained Earnings of Rs. 29229.31 crore is quite a large amount. Especially needed for a company that’s in a business such as FMCG. Hence, we can say that though the company is not in zero debt (there cannot be a company with zero debt). The company’s financial position is well secured and well funded. 

Companies will require credit (debt) to operate the day-to-day activities. Though the company has a sufficient cash reserve. They tend to take loans and other modes of financial intermediaries to assist in their production and management for the same is proved (if allocated well) to be cost-efficient and better utilization of resources. 

Cash Flow Analysis:

Post adjustment, the company has provided an operating income of Rs.12,527.09 crore. The company has spent as in Financial activities (Dividend paid, payment of liabilities, etc) amounting to Rs. 18,633.83 crore of which Rs.18,881.39 was paid to shareholders as dividend. Thus, providing a net cash inflow amounting to Rs.310.16 crore. 

The equity and Debt ratio is at a comfortable range. Interest coverage ability is extremely good. Return on Invested Capital is good thanks to “Cigarette business”. And, at EPS of Rs.10.7 and over 80% of which is paid out to shareholders as dividend. 

The liquidity status of the company is positive in both the Current ratio and Cash ratio. And, as per my calculation, ITC per share, fair value is to be quoted at Rs. 155  (Will share my method on the YouTube channel link is here). But, the market always quotes premium and especially the case in this bull run. So, it is fair to pay at max, Rs. 170 – 185 per share. (max 20% premium) (I have right to be wrong)

Why is the ITC stock falling?

There are many reasons for the stock price to react the way it does. In the stock market, there is a reaction for each action. The price reacts to related or unrelated activities in the market. Few reasons noted for the share price drop are as follows:

1. Disposal or Pledge of a large number of shares by Designated persons.
2. Negative news or rumors about the company/sector.
3. Unexpected negative financial figures.
4. Mis-management intentional or unintentional that affects the Company.
5. Change in Future perspective or outlook.

Have looked into the above-mentioned points and the company came out clean. The company financially is doing reasonably well. I see no reason for the same to go bad in the near term. Though I have found some issues, the same will be discussed in the latter part of this article. I’m positive about the company’s overall performance and wellbeing. Disappointed at some.

Pros of ITC company:

1. Although ITC is a Tobacco business where the company gathers most of its earnings, the company in recent years ventured into FMCG, IT, Agri and Hotel business. A healthy diversified business, the fruits of which can be flavoured in later days.
2. A major dominance in cigarette business. The company holds a sheer monopoly in the industry and will continue to do so.
3. As explained above, companies financial stability is positive and cash position is extremely good. 
4. FMCG business growth is showing results and if not or Covid void, we would have seen much better results.
5. Strong brands value not just in cigarette business but also in FMCG and hotel businesses.
6. Robost free cash flow and high Return on capital employed.
7. Large CAPEX investments into FMCG and Hotel business. 
8. In the last 10 years, ITC FMCG business grew at a CAGR of 33%. And, the same will continue thus, bringing down the dependency on cigarette business revenue.
9. 5 years average sales growth is at 6.5%, amongst best in the industry.

Cons of ITC company:

1. Cigarette business is a SIN product hence, regulatory issues may come at any time.
2. Extreme stock dilution has made the equity shareholding unfavorable due to clumsy holdings. 
3. No promoter group, no stock backing thus,the free float equity shares have no backings.
4. Covid restrictions affect Hotel business at large, But, impact the entire business through other business segments too.
5. Cigarette business is slowing down. And, that’s the cash cow!
6. High dividend payout (at over 80% of net earnings) has made the company vulnerable. It also raises doubts about companies ability to service the dividend payouts in future.
7. Research and Development Expenditure to Gross Revenue is extremely low at just .3%
8. Cigarette business contributed over 80% of the company’s bottom line profit. Wherein, FMCG business provided in single digit with extremely low operating margins.

Reason for ITC pricing!

Extreme stock dilution has been seen in the past three decades. The company has over 1,230.88 crore equity shares, that’s equivalent to 10 shares for every Indian (As per the 2011 census population). The management has allowed for 5 Bonus issues and 1 stock split resulting in an excess amount of shares in the holder’s account at the same valuation. This optimum dilution results in an excess volume of shares to be traded in the market. Resulting in more volatility.

Stock Dilution List:

The chart above says that, If an investor had bought 100 shares at the beginning of 1991. He/She would be holding 15,840 shares (Excluding Rights Issue) as of 2020. This stock dilution had made access to the retail investor to buy the shares at a lower price. But, the same doesn’t provide any additional value to the investors. It just seems the price is cheaper where in fact the value remains the same.

Example: If you own 100 shares of ITC at a Face value of Rs.10 per share. It is equivalent to Rs.1,000 worth. And, If you own 1,000 shares of ITC at a Face value of Rs.1 per share. It is the equivalent of the same Rs.1,000 worth. When the stock is diluted, the number of shares free float increases. If you own 1% of ITC, post a 1:10 stock split. You’ll still own the same 1%. Just the number of shares you own has increased. 

The dilution is like giving us 12 slices of pizza and saying it’s more when the same is given to each of the shareholders. It makes no difference. You are just increasing the number of slices. The actual quantity of pizza remains the same (1 Pizza = 12 Slices). The split, Bonus & Rights Issues have given us more shares (Pizza slice). The intrinsic worth of the company remains the same (1 Whole Pizza). 

When equity is diluted and stock prices reach such a stage that every speculator in the Stock market could afford to trade. In such cases, the number of quality holders gets reduced and quantity holders increase. But, this new class of shareholders has a clumsy mindset hence, weak holdings. They are not stable. Hence, the stock moves various hands over a trading period. Resulting in the valuation staying the same for a considerable period.

Is ITC a good stock for long-term investment?

Unfortunately, many investors chase unknown companies in the hope to catch a multi-bagger stock. But, on this journey. The budding investors give less consideration towards the safety of Capital allocated. Remember, one has to first consider saving his capital, and then comes returns. 

And, such companies that are well established and are as ‘Cash Rich Companies’ as ITC are less likely to go broke. Hence, might be a great addition to one’s portfolio as a long-term investment.

Here are some financial figures:

What is the future of ITC shares?

If you are someone like me. Who believes in India’s “Democratic Capitalism”. Then, you’ll surely be optimistic about the Indian market in general. I believe a new shift in the consumption-driven economy that’s ought to happen will drive sectors such as FMCG, Insurance (personal & others), Banking and Financial Institutions, and many such to new highs. 

ITC being a prominent FMCG company. I see more reason for the company to monetize its already established market position to pick up and generate value to the investors. Hence, I believe that the company is worth well in years to come.

The company should consider this!

Cash position – I would rather see the company be fully invested in various investments and other activities than to see it be sitting in a cash position.

Dividend policy – FMCG sector is both ‘cut-throat competitive’ and ‘Cash sensitive’. And to see the company give out more of its cash as in ‘divided’ is worrisome. For the year ended March 2020, the company has provided dividends worth Rs. 7048.71 crore to its shareholders.

Research and Development Expenses – The company’s R&D Expenses are at 0.34% of its Gross Revenue. Amounting just under Rs. 155.39 crore for the year ended March 2020. FMCG companies, considering their competitive spirit. I wish the company gives more consideration towards the R&D spendings.

Stock Dilution – Extreme Stock dilution has led to such low stock prices. The stock has not moved further for about a decade now. Mainly due to the split, bonus, and rights issue. This amount of free float of equity (Over 1,230 crore share count) is worrisome for the same has a huge impact on the stock price, whether due to volatility or otherwise.

Is ITC shares worth buying?

It depends on the type of Investor one is. Investing has always been termed risky (If one doesn’t know what he/she is doing). My question would be – “Do you think not investing is risk-free?”. In fact, not investing would be the riskiest of all. You take a chance when you don’t invest, be it equity or any other asset class. A chance that’s gonna turn out to be very costly in the latter part of your days. 

If saving is your only option for retirement. Check out the savings interest income and the yearly inflation rate increase. Now, we have established that investment is the only option. How to invest? The answer can be answered in many ways. Two of which are:

1. Learn before you Earn.
2. Take professional help.

To the majority of individuals, I suggest the latter. But, I personally believe in the prior one. 

Disclaimer: I’m not a SEBI-registered advisor, do a thorough analysis before investing, and do consider your investment advisor for more information.

Conclusion:

Most individuals fail in Stock Market Investing not because their investments made lousy returns or failed over time. But, because they made a mistake in Equity allocation. 

What most do is that they, once introduced with new Company to invest, without further planning, dump in half of their entire portfolio into one stock and by the end of the investment period, reflect on their investments which would have gone bad thus pulling the entire portfolio to drain or made good money by one stock and are in the heights of their lifetime.

Which unfortunately won’t hold them high. Because they are bound to repeat their strategy of pumping more money into one stock and thus go broke!

Check this article to know more about “Equity portfolio allocation”. Click here!

So, if you are already holding ITC limited in your portfolio. And, if the same is over 5% of your portfolio weightage. Then, your investment advisor might ask you to trim your holdings.

In my portfolio. I hold ITC at 1.65% of the entire portfolio weightage and am considering increasing the holdings up to a max of 3% of the entire portfolio. I have been holding ITC for a long period and would hold for the next 10 years at least (as per current goings). 

To check my portfolio. Click here!

YouTube video for more information:

Disclaimer: All the information on this website is published in good faith and for general information purposes only.

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