ITC a let-down but Street upbeat

ITC, despite being the most attractively valued among the Nifty FMCG stocks, continues to underperform its peers as well as leading indices. In CY20 so far, the stock has lost 25 per cent against the Nifty FMCG index gaining 2 per cent, and a 5.3 per cent fall in the Nifty50 during the same period.

However, analysts say, it may have hit the trough and with the FMCG (non-cigarette) business gaining pace, operations in cigarettes near normal, and a high dividend yield, the stock is attractive.

A tax overhang and ESG (environmental, social and governance) concerns over cigarettes have been among key factors hurting investor sentiment. While the company earns over 85 per cent of its operating profit from cigarettes, which also justifies the Street’s concern, analysts believe there is very little to lose at current valuations.

At around 15.5x the 1-year forward estimated earnings, the ITC stock is not only trading at a 54 per cent discount to Nifty FMCG’S 1-year forward valuation but also 35 per cent lower than its own historical valuation mean.

Vishal Gutka, vice-president at Phillipcapital, said: “Though there are some concerns such as a likely increase in the cigarette cess, we believe ITC’S current valuation, along with factors such as the growing non-cigarette FMCG business and higher dividend yield, indicates limited downside risks for investors.”

While ITC announced its new capital allocation policy of paying 80-85 per cent of its profit after tax to shareholders in the medium term in March this year, analysts at JM Financial say the FMCG business has the potential to drive the stock’s rerating in the medium term.

In the June 2020 quarter (Q1), the performance of ITC’S FMCG business was impressive, with the essential products portfolio (staples, convenience foods, and health and hygiene) growing by 34 per cent year-on-year. Though sales of the discretionary part of the FMCG segment remained under pressure in Q1, they are likely to normalise as the economy is getting unlocked.

Notably, Ebit of ITC’S FMCG business surged 60.7 per cent year-on-year to ~125.4 crore. ITC has been open to making acquisitions. In late July, ITC acquired spices manufacturer Sunrise Foods in an all-cash deal worth ~2,150 crore. This acquisition can add to the FMCG business’ margins and is scalable too.

Though FMCG’S profit contribution is minuscule (around 5 per cent), Shirish Pardeshi, analyst at Centrum Broking, said: “ITC has all the ingredients to support the stock with scaling up its FMCG business. Also, given the higher demand for packaged food in Covid-19 times, we can expect faster recovery in profitability.”

While for the cigarette business competition is rising mainly in the lower-end of the segment, ITC’S large market share of over 75 per cent across the states and strong pricing power offers comfort.

Importantly, it is recovering well from the pandemic impact. In a report this month, analysts at Axis Securities said: “June and July have seen a healthy recovery in the core cigarette business driven by rapid scale up in operations, supplychain normalisation, market share gains (competition plants remained close), innovative product offerings (5 sticks cigarette pack vs 10 sticks standard pack, new launches in 64mm size) and trade promotions in king size/regular size filter tip. These, we believe could support earnings momentum in FY21.”

While its hotels business is facing rough times and is likely to be a drag in FY21 (among reasons for flat earnings growth), the agri and paper and paper boards businesses are expected to see a gradual improvement, said analysts.