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The post-budget rally in ITC Ltd shares, as it turned out, flattered to deceive. ITC shares jumped over 15% in the budget week after the government left cigarette taxes untouched. But the stock gave up over half of those gains last week, part of it due to weaker-than-expected December quarter results.

The stock trades at about 217 apiece, languishing below its pre-covid highs a year ago. Other consumer goods stocks surpassed their pre-covid highs several months ago. The Nifty 50 index crossed the hurdle three months ago. While ITC’s underperformance isn’t new, investors remain confounded about the extent to which the stock is lagging behind. Other laggards such as State Bank of India and Larsen and Toubro Ltd have recovered sharply in the so-called reopening rally since end-October, rising 107% and 64%, respectively. ITC’s recovery in the same period has been a far more modest 33%.

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“ITC is a value stock and is likely to remain a value buy forever it looks like," says a fund manager.

Note that ITC’s annual profits are more than double those of Hindustan Unilever Ltd (HUL). But its market cap is exactly half of HUL. Varun Singh, an analyst at IDBI Capital Markets and Securities Ltd, said, “HUL’s Ebitda rose at a compound annual growth rate (CAGR) of 13% in FY15-FY20 against 6% Ebitda CAGR of ITC. If HUL grew Ebitda more than twice the rate of revenue growth, I would say it has done very well to make the cost of execution cheaper. This trend is not visible in ITC with similar intensity. Also, in ITC, except FMCG-non-cigarette business, all other segments are witnessing margin pressure, and that doesn’t augur well." Ebitda is earnings before interest, tax, depreciation and amortization.

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ITC’s relatively slower long-term growth outlook also keeps a check on valuations. An Emkay Global Financial Services Ltd analyst says, “For ITC, adverse government regulations, reduced affordability of cigarettes and a huge market of illegal cigarettes has weighed on volumes in the past."

Further, in recent years, environmental, social and governance (ESG) concerns have loomed large for global tobacco stocks. “Accordingly, ITC has seen a lot of foreign fund outflow. Just about three years ago, ITC stock used to trade at about 25 times one-year forward earnings and, now, the shares trade at 15 times," pointed out Emkay. The broking firm maintains, "Even as ITC’s long term growth outlook is slower compared to the usual FMCG businesses, we expect with increased mobility post easing of covid-19 restrictions and opening up of offices and colleges, to help the company witness good volume recovery, going ahead. Further recovery in cigarettes/other divisions can lead to an upgrade in FY22/23 forecasts."

For now, muted cigarette volumes amid lockdown is a factor weighing on sentiments. December quarter results are not inspiring as well. Analysts estimate cigarette volumes to have declined by about 7% last quarter. Plus, ITC’s FMCG growth has moderated with pandemic-related tailwinds easing. Like-to-like FMCG revenue growth for the December quarter is at 11% year-on-year, down from 18% seen in the September quarter.

Shyam Sekhar, co-founder of iThought, an investment advisory services firm, and a shareholder, said “Another problem is they are choosing a less efficient method of giving back to shareholders by giving dividend instead of doing a buyback." ITC declared an interim dividend of 5 per share, which marks a departure from the past when it gave out dividends only once a year. “Given the derating in valuation multiples due to ESG, one way it can boost investor confidence is by doing a buyback."

Investment analysts Michael J. Mauboussin and Dan Callahan point out in a Credit Suisse note titled Disbursing Cash to Shareholders, “Buybacks benefit ongoing shareholders when management buys stock that is undervalued and benefit outgoing shareholders when the stock is overvalued. Since management should focus on building value per share for continuing shareholders, it should always try to buy back shares that are undervalued."

JM Financial Institutional Securities’ analysts sum up the outlook for the stock well: “The stock is likely to stay muted, given the absence of any solid business trigger for now. Valuations are cheap vis-a-vis other stocks in the sector, but that reason alone is unlikely to help the stock higher in the absence of growth or narrative."


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