The stock is finally drawing attention. Most analysts said the time-wise correction on the counter is nearing an end. Some of them project 60-100 per cent upside in the stock in 12-24 months.
Known mainly for its cigarettes, analysts said the FMCG division of this diversified company has possibly been one of the most under-appreciated businesses in the Indian consumer space in recent times. You guessed it right; the stock is ITC.
“In 10 years, the FMCG business would alone justify the company’s prevailing market value,” the brokerage said, adding that the addressable opportunity for this company at this moment is $22 billion, which is larger than peer HUL’s markets and more than 3 times that of Nestle India’s.
On Monday, September 28, the widely-tracked stock had 18 ‘buy’, 9 ‘outperform’ and 6 ‘hold’ calls. The stock, which is down 28 per cent in 2020 against Sensex’s 8 per cent fall, had no ‘sell’ calls.
Why so bullish?
The company has withstood repeated tax hikes on tobacco products and successfully diversified its FMCG portfolio, which is yielding results now, said analysts.
“Profitability is low at present, but we reckon with the investment phase largely over and profits and cash generation would get much bigger from here on,” JM Financial said.
Elara Capital said cigarettes are cash-cow for ITC with a strong moat. “This business enables the company to have consistent cash flow, powering its food business to chew a mouthful of initiatives,” the brokerage said, adding that six of the company’s 11 FMCG brands are still in the incubation period.
“ITC is emerging as a foods company, which is comparable more with Nestle than HUL. In our deep dive analysis into ITC’s foods business, we concluded that it is on the cusp of a take-off, both in terms of top-line and margins,” it said.
FMCG giant ITC reported a 26.18 per cent year-on-year (YoY) drop in profit at Rs 2,342.76 crore for June quarter against Rs 3,173.94 crore reported for the same quarter last year. Revenue from operations, the company said, dipped 17.39 per cent to Rs 9,501.75 crore against Rs 11,502.82 crore in the year-ago quarter.
Revenue from cigarette sales stood at Rs 3,853.79 crore while total FMCG revenue, including those of cigarettes, came in at Rs 7,228.36 crore.
The company said the impact of Covid-19 pandemic on the carrying amounts of property, plant and equipment, intangible assets, investments, inventories, trade receivables, etc. was insignificant.
Free cash flow
ITC’s free cash flows (FCF) jumped 30 per cent YoY in FY2020 to Rs 11,700 crore led by a reduction in working capital and lower effective tax rate. In the past six years, ITC’s FCF growth was a healthy 17.7 per cent annually, said Kotak Securities.
FCF/Ebitda for FY2020 stood at highest level in the last many years, at 65.3 per cent.
Besides, return on equity (RoE) for FY20 expanded 60 basis points to 23.3 per cent, even as asset turnover came down. However, return on capital employed for the year declined to 25 per cent from 27 per cent in FY19 due to weak operating profit growth.
Mutual Fund participation missing
Sandip Sabharwal of asksandipsabharwal.com said that at the current market price of Rs 170, and taking into account the 6 per cent dividend that ITC pays and the huge cash flows it generates, it is tough to lose money on this stock at these levels.
The risk-reward is favourable, he said.
Analysts, however, noted that while a lot of analysts recommend the stock, mutual fund portfolios do not really hold ITC. Top 10 of 15 largecap funds do not hold it as a long slump in the stock has ‘frustrated’ them.
The stock was down 16 per cent in 2019 when BSE Sensex rose 14 per cent. In 2017, it rose just 9 per cent against Sensex’s 28 per cent rise. In 2016, it fell 25 per cent against Sensex’s 1.94 per cent rise. In 2015 and 2014 as well, it underperformed the benchmark index
“If there is some positive news on the FMCG business, it could actually create a good move on the counter. I would be more on the buy side at its current price,” Sabharwal said.
Kotak finds valuation for the stock inexpensive. “ITC has undergone a time correction and de-rating over the past eight years even as EPS and FCF compounded at annual growth rates of 10 per cent and 15 per cent over FY12-20.
“We believe concerns around cigarette taxation in view of stretched government finances and increased focus on ESG-compliant investment are more-than-adequately priced in. The stock offers a good combination of inexpensive valuations at 13 times September FY22 PE, healthy dividend yield of 6 per cent and promises solid long-term growth in FMCG,” it said.
Kotak’s fair value of Rs 260 on the stock suggests a 50 per cent potential upside.
JM Financial has an even bigger target of Rs 275, which suggests nearly 60 per cent upside.
“At ITC’s FY30-based valuation (discounted to present value), FMCG alone would justify half of present market value. This implies that the cigarette business, which generates 85 per cent of profit is currently valued at just 4-5 times PE,” the brokerage said.
Centrum has a price target of Rs 351, projecting a 100 per cent upside in two years. It noted that ITC commands a market leadership position with 75 per cent market share and best-in-class profitability and return ratios, and thus, it has assigned a 10 per cent premium to its cigarette business valuation over peers VST Industries and Godfrey Phillips.
It said ITC’s improving profitability profile is still lower than Britannia’s, and thus it has assigned a 20 per cent discount to its FMCG business over Britannia’s three-year average EV/sales.
The brokerage finds a strong moat in ITC’s agri-business, given its connection to the hinterland through e-choupals and strong affinity among the farmer community. Centrum gave a higher premium to ITC’s paperboard divisions and in-line valuations to its hotel business to arrive at its target.