ITC has a strategy of effectively utilizing the excess cash generated from its cash cow, the cigarette business, to strengthen and enhance its other non-cigarette businesses.
The cigarette business contributes more than 45% to its top line and over 80% at the operating level.
In spite of its exit from the non-filter cigarette business, the net revenues of its cigarette business grew by a handsome 10.6% year-on-year (y-o-y) in H1FY2009. The growth was driven by the large-scale upgradation of smokers from the non-filter cigarettes to filter cigarettes and price hikes undertaken by the company across its cigarette portfolio.
However, the government’s attempts to curb cigarette consumption (by banning cigarette smoking in public places and making pictorial warnings on cigarette packs mandatory) do not augur well for ITC’s cigarette business in the near term.
Therefore, the company aims to strengthen its presence in the other non-cigarette businesses, such as hotels, agri-products and FMCG, over the next five to seven years.
The company believes that the declining valuations of assets in the current economic slowdown and the huge pile of cash (Rs5,623 crore in FY2009E) on its books provide an opportunity to acquire assets at an attractive price.
Occupancy levels and average room rates (ARRs) in the hotel industry have fallen because of the ongoing economic downturn, an oversupply of rooms and the recent Mumbai terror attacks.
This has dented the valuation of the companies in the hotel industry. Sighting opportunity, ITC has firmed up plans to acquire hotels to increase its presence in various segments (such as luxury, leisure, business and economy).
At the current market price of Rs172 the stock trades at 19x its FY2009E earnings of Rs9.1 and 15.9x FY2010E earnings of Rs10.9. We maintain our BUY recommendation on the stock with a price target of Rs218.