ITC, India’s largest company by market cap in the FMCG space, has been one of the topmost wealth creating companies over the last decade or so. Its market cap improved substantially from Rs 20000 crore as of March 2001 to the present Rs 1.56 lakh crore. One of the main reasons for the company to outperform on the bourses is that, a decade ago the company made an announcement to diversify into other FMCG products so as to reduce its dependence on the cigarettes business.
This de-risking strategy was appreciated by the investing fraternity since cigarettes as a product has been facing a lot of regulatory pressures from across the world. Very recently ITC was in the news as one of the NGOs raised questions about LICs investment in the company even as the government is spending huge amounts on tobacco related illnesses.
LIC is the second largest shareholder in ITC with a 12.72% stake in it. But even after more than 10 years the 'FMCG-Others' segment (as defined by ITC) has not yielded the desired results and hence the obvious question that comes to mind is whether ITC can repeat its outperformance on the bourses over the course of the next one decade? We have our doubts.
It is time that the more than four lakh shareholders of the company ask the ITC management several questions that will help them understand about the kind of growth that can be expected from the company going forward. Our sincere efforts to meet YC Deveshwar, chairman of ITC, could not bear fruit due to his “several pre-commitments”.
Even our detailed questionnaire sent to him and the head of the company's corporate communications department was not responded to on the pretext that the company’s shareholders knew everything that needs to be known.
"We believe that our shareholders have been adequately and comprehensively informed of all developments including all the statutory requirements," the corporate communication head replied. Shareholders of the company can decide for themselves, after reading this story, whether they were aware about the information that has been spelt out here.
ITC is a hugely diversified company having various revenue streams ranging from paper to hotels, packaging boards to soaps, branded flour to garments, and the IT & ITES business. The company has been making constant efforts and more so from 2001 to diversify its revenue streams so that it can have a good and balanced portfolio. In fact, in most of the interviews granted by the management to the media, emphasis has been placed on how ITC has a well diversified business. However, our study of the last 10 years’ balance-sheet of the company paints a different picture altogether.
ITC continues to rely heavily on its cigarettes business which is its core, to be its revenue driver. Our study shows that for the year ending March 2002, revenue from cigarettes (excluding trading in tobacco) contributed up to 81% to the company’s consolidated topline. Even after 10 long years the scenario is not much different. The cigarettes business continues to dominate the topline with a share of 65% in revenues.
This is despite the fact that ITC has launched a host of new products in the non-cigarettes segments in the last 10 years to drive its topline as well as its bottomline. The picture is more worrisome when we look at the bottomline since the company's dependence on cigarettes continues to be very high with more than 80% of its profit (earnings before interest and tax) comes from the cigarettes business.
In the year 2002, its cigarettes business contributed up to 94% of the company’s earnings before interest and tax and in 2011 this works out to a whopping 82%. In other words, hotels, FMCG-Others (that includes many various sub-businesses), agri-products, paperboards, paper and packaging and its IT business put together contribute a little over 15% to its profits despite many of them being in the field for a decade or so.
We, at Dalal Street Investment Journal, believe that its cigarettes business would continue to drive the bottomline at least for the next one more decade, if not more. It would be right to conclude therefore that ITC is more of a cigarettes player rather than a well diversified FMCG company and that it has failed to reduce its dependence on the cigarettes business despite its many assurances to the shareholders. LIC must take a note of the same and should not make people believe that ITC is no longer a tobacco company.
The present industry age is that of developing core competency and so companies across the world are becoming leaner and fitter and focusing on what they understand the best. Ironically then, ITC has businesses which have no synergy with each other and yet continue to operate under one company.
While we understand that ITC has a stronghold over the retail chain since cigarettes are sold through big and small vendors, yet it is difficult to see what is common between hotels or sale of branded stationery books for school children or for that matter the production of branded flour for housewives or garments stocked in upmarket malls or its IT and ITES business.
Very recently in the US, Indra Nooyi, chairman and chief executive of PepsiCo, came under criticism as PepsiCo slipped to the number three position in the aerated beverages market with the critics alleging that the management was not paying enough attention to its flagship brand because of its diversification into other products.
We are not sure how much of its management bandwidth is ITC able to provide to each of its verticals. In our opinion, ITC has opened too many frontiers, each of which faces tough competition, and this can create problems for the company going forward in terms of defining and achieving growth.
It would therefore make more sense for ITC to demerge its non-synergistic businesses into various companies and offer shares to its shareholders the same way Reliance did a few years ago. This would usher in a clear and focused approach for each of its business segments and the shareholders of the company would be rewarded in a much better manner.
When will the 'FMCG-Others' segment report profits?
Those who are not aware need to be told that ITC, as a part of its diversification plan to reduce the company's dependence on its cigarette business, had ventured into the 'FMCG-Others' segment way back in FY2001-02 with the launch of ready-to-eat packaged foods under the brand name 'Kitchen of India'.
The following year it launched branded staples under the tag 'Ashirvaad', confectionery with the introduction of 'Mint-O' and biscuits with the name 'Ibischips'. The Sunfeast brand of biscuits was launched much later. Every year the company has been launching new products in this category to be able to take its topline forward.
However, despite putting their best foot forward, the performance has been devoid of any shine or glitter. The bad news is that a study of the annual reports of the past 10 years reveals that nowhere has the management spelt out clearly when this division will see a turnaround in its fortunes.
Over the years, its product portfolio has increased to include éclairs, spices, soaps and shampoos and, surprisingly, also has academic books under the brand name 'Classmate' which, the company claims, has a record reach. There is also the apparel business with tags like Wills Classic and John Players. For each of these products, ITC has to compete with giant players. For example, it has to compete with HUL for soaps and shampoos and with Parle and Britannia for its biscuits.
Our study points to the fact that this overloaded portfolio has resulted in the accumulation of losses year after year. There has been no sign of profits at all since FY2002 with the collective loss of this division at its EBIT level totalling up to Rs 2394.95 crore. This implies that a huge amount of money has been spent by the company to build this business with very few positive outcomes. To gain a wider perspective on this loss, consider the fact that Colgate India has an annual turnover of Rs 2394 crore.
How long will it take this segment to wipe out its accumulated losses?
It is high time – at least for the sake of the company’s shareholders - that this segment started posting profits. After all shareholders have a right to aspire for good returns on their investments. Unfortunately, the management continues to remain pretty non-committal. What is even more disconcerting is the fact that the company has gone all out to promote its brands with endorsements from some of the best known celebrities.
Shah Rukh Khan promotes the Sunfeast brand of biscuits while Hritik Roshan promotes John Players (very recently they roped in Ranbir Kapoor for the same brand). Deepika Padukone and Kareena Kapoor endorse the personal care products and Sachin Tendulkar does it for the Fitkit range of healthcare products of the company. While sales are yet to come in (which is reflected in the poor profitability of this segment), the high cost of endorsements are surely hitting the company hard.
Comparing the company’s topline graph in this segment for the past four years along with that of its competitor Godrej in the personal care product segment, we find that in the last four years ITC's topline grew at a CAGR of 27.3% while Godrej saw its topline grow at a CAGR of 33% and that too with a strong bottomline growth unlike ITC. Another cause for concern is that none of ITC’s products are leaders in their categories. This is true of branded garments as it is in case of other categories like soaps and shampoos.
Similarly, it is in a distant third slot in the biscuits category with just about 10% of the market share. New players like Cadbury have entered this segment further creating a strain on an overcrowded market and pushing ITC away from the target of achieving a turnaround. The only segment where the company could gain leadership position is with staple flour sold under the ‘Aashirvaad’ brand with its turnover in the region of Rs 1000 crore. We are unable to understand why the company is not consolidating its present verticals rather than launching more products every year, thus creating bandwidth problems for itself.
Last 10 years "FMCG-Others" sales and Accumulated losses |
FY | Sales (Rs/Cr) | Accumulated Loss (Rs/Cr) |
2002 | 21.5 | 73.44 |
2003 | 109.2 | 195.88 |
2004 | 303.84 | 370.37 |
2005 | 563.9 | 565.54 |
2006 | 1090.49 | 738.53 |
2007 | 1713.46 | 934.53 |
2008 | 2526.6 | 1193.49 |
2009 | 3035.47 | 1683.09 |
2010 | 3661.26 | 2063.43 |
2011 | 4495.06 | 2394.95 |
Why have there been no consolidated quarterly results?It comes as a surprise to us that ITC does not declare consolidated quarterly numbers. The company discloses its consolidated numbers only at the end of the year in March.
Why is this so, despite it being a constituent of the Sensex and theNifty? A majority of the professionally managed companies declare their consolidated numbers so that investors at large can gain a better understanding about the company and its performance. In this case, shareholders are forced to come to their own conclusions on
the basis of only stand-alone numbers. The consolidated numbers are
important for the simple reason that ITC has a very complex corporate structure with its 10 subsidiaries and the various companies under its subsidiaries, not to forget the JVs.
Hence numbers would matter a lot to the shareholders. Since ITC has a major chunk of its operations in the domestic market (92% of its revenue are derived from within India), it should be relatively easy for the company to declare its consolidated results. If
Tata Steel ,
Tata Motors and
Infosys , just to name few, can do so despite having widespread global businesses, we see no reason why ITC cannot do it.
Why is the company reactive when it comes to launching its products rather than being proactive?
When we look at the products that have been launched by ITC under its FMCG-Others’ segment, it becomes apparent that these have been inspired by its competitors. Take, for instance, the 'Bingo’ brand of potato chips. This product was launched by ITC in FY2007 and we believe that this was launched after looking at the success of ‘Lays’ from PepsiCo.
Even the company's entry with 'Tedhe Medhe' in FY 2010 was after the success of 'Kurkure'. The company this year has launched a product called ‘Sunfeast Yippee Noodle’, an instant noodle inspired, no doubt, by the popularity of Maggie from Nestle.
Why doesn’t the company come up with innovative products on its own and become a trend-setter for a change?
The company in its annual report claims that over the years it has invested significant amounts in R&D for product development. It is high time then that these efforts provide positive results. According to the figures available, over the past five years the company has spent Rs 483.62 crore on R&D but there is no clarity about how much of this was spent exclusively on FMCG-Others.
The scenario is also similar in its personal care products where the branding exercise with the use of leading actresses from Bollywood was an imitation of the strategy employed by Hindustan Unilever for its Lux soap. The same is the case with biscuits too.
In fact, Britannia, its competitor in biscuits, has now come out with many new products that harp on good health and our sources suggest that they have been well accepted by consumers. Shouldn’t ITC feel the need to show some catching up? Consumers need something new all the time and ITC needs to learn from its competitors like PepsiCo (Kurkure) or Nestle (Maggie) or Marico (Saffola) to create a niche for itself in a highly competitive industry.
When will the company unlock value from its unrelated businesses?
Various companies in the past have carried out an exercise of unlocking value to help benefit shareholders. Tata Steel, which did so by divesting its non-core business of cement is a good example of this. Similar was the case with L&T when they sold their cement business and recently went public with L&T Finance Holdings. Reliance Industries has done so by giving shares of various companies to its shareholders and Bharti Airtel transferred its tower business to focus on its core segment of telephony.
We feel, ITC needs to do something on similar lines so that each of its businesses can be listed. This will help improve shareholder value. ITC should review each of its businesses and should ask itself the critical question of whether it should continue to remain in that business.
Take the case of ITC InfoTech, a 100% subsidiary of the company that has been going nowhere in terms of profit. In fact the revenue is so marginal that the company prefers to push it into the ‘others’ category while disclosing its segmentwise revenue. It gets clubbed with income from filter rods and investments.
As such, ITC InfoTech is a complete misfit in the business plan of the company and should either be divested or put up for a joint venture to give it a bigger platform. If one looks at ITC InfoTech’s profit numbers for the last five years, they have deteriorated substantially from Rs 20.67 crore in FY2007 to Rs 7.46 crore in FY2011. In fact, the company saw a big fall in its net profit last year from Rs 34.02 crore to Rs 7.46 crore.
We are not able to recollect any other company in the infotech business that witnessed such a huge dip in net profit for FY2011. Yet the annual report of 2011 claims that ITC InfoTech is among the country’s fastest growing IT companies in the mid-tier segment. This claim is shocking, to say the least. Under what parameters has the company made such a claim? It would be in the larger interest of shareholders for the company to seriously consider bringing about a drastic change to be able to generate a decent revenue level.
Why are disclosures to shareholders lacking in transparency?
When it comes to disclosures the company has a great scope for improvement. We have mentioned how the company does not reveal its consolidated quarterly numbers. Even in its annual reports, there is a lot lacking in terms of information despite it running into more than 150 pages. For instance, the shareholders of the company are unaware of how big the 'Aashirvaad' brand is or how much revenue 'John Players' brings in for the company.
This is primarily because the company is very selective in providing information to its shareholders. Just to continue with ITC InfoTech's net profit drop, the annual report does not give any insight about why it has declined despite an improvement in the topline. Worse still, the annual report does not give any idea about when InfoTech's numbers would start improving.
The scenario is no different when it comes to its personal care business. How big Vivel or Fiama Di Wills brands are remains unknown.
There is also no mention about which segment of FMCG-Others is profitable. One obvious argument here would be that the company does not wish to give away information that can help competitors. But this could be a lame excuse considering that competitors are smart enough to know what kind of sales the company's brands are generating in the market. Nielsen, a market research agency, compiles information of various FMCG products and the same is available by subscription. ITC's competitors know the ball park figure of each the brands and therefore not disclosing information for such a reason would have to be taken with a pinch of salt.
Given the fact that the shareholders are the owners of the company, it is only fair that they should have details about which of the company’s brands are growing or stagnating. What is also surprising is that ITC does not hold an analyst meet. This is something rare among the
Sensex-based companies. Today transparency is essential and investors, in particular, are willing to pay premium to those companies who do not play the hide-and-seek game. Therefore, the least ITC can do is to hold an analyst meet on a regular basis. We are not sure how analysts and fund managers are valuing the company as any key data that can help evaluate the company is missing.
Since ITC is the largest market cap company in the FMCG sector, it should set standards for others to follow in terms of disclosures, even though some of the disclosures are not statutorily mandatory.
Infosys set the standards in terms of disclosures, and investors appreciated it. In a recent interview Narayana Murthy of Infosys, said, “If I know what I am going to do and don’t tell you, it is not fair. If both internal and external shareholders are not informed about the future of the company, I would be creating asymmetry of information, and that would lead to insider trading”. There is something that ITC could learn from these words.
Valuations (Table)
How should one value ITC as a company?
While it is possible to value the company as a sum of its parts, due to its various business streams, we would prefer to value it on a P/E basis, as it derives more than 80% of its profit from one segment, i.e. cigarettes. We have evaluated the various international cigarette companies and taken a two-pronged approach of valuations: one, with the time-tested P/E ratio, and the other, based on its ratio of sales to market cap.
Our findings suggest that the average P/E cigarette companies command is in the region of 15-17x, with the highest being commanded by Imperial Tobacco, at 24x. On the other hand, ITC is commanding P/E at more than 30x.
In terms of sales to market cap average ratio, this is 3-4x, but in case of ITC it is more than 7x. This gives a clear idea of where ITC stands today in terms of valuations.
We have not compared the firm with any domestic cigarette manufacturing company for the simple reason that they are relatively very small players, and hence, any such comparison may not be fair. However, we did compare ITC with Hindustan Unilever, another FMCG giant.
Hindustan Unilever is commanding P/E at 29x but enjoys much better returns on net worth (RONW) at 88%, against ITC’s mere 31%. One of the reasons why ITC is commanding lower RONW is the diverse business segments pulling down the overall numbers. In fact, the company is amongst the lowest-ranked FMCG companies when it comes to RONW, as indicated by the table.
Further, we believe that the cigarette business would face headwinds going forward, on account of the regulations on smoking becoming stringent day by day. This, we believe, may impact the volume growth of the company. Since 2002, the company’s cigarette revenue has grown by 11% CAGR, while profits have improved by 15% CAGR.
We expect both the topline as well as the bottomline to grow in single digits in the coming years. This will impact the premium that ITC is able to command on the bourses. Looking at the valuations and the likelihood of a slowdown in its main business, we are of the firm opinion that ITC will underperform the broader market, and hence one should book profit from the same. The company’s honeymoon period on the bourses may soon be over. It is time to look for another ITC to create wealth
