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Home >Markets >Mark To Market >ITC stock gets some light finally, but ESG concerns still loom large

It would have been really odd if the ITC Ltd stock didn’t lift itself out of misery when every other stock is staging a so-called ‘catch-up’ rally. ITC shares have finally surpassed the psychologically barrier of Rs200 per share this week, having risen by about 25% since end-October, more or less in line with other stocks such as Larsen & Toubro that are also playing catch-up.

ITC’s Achilles’ heel has been its cigarettes business, which contributes around 85% of its FY20 earnings before interest and tax (Ebit). In recent years, global tobacco stocks, including ITC have borne the brunt of ESG (environmental, social and corporate governance) concerns, which has led to a decline in price-to-earnings multiples. The company has been lately pointing out to investors that it has some offsetting factors on the ESG front – that it has been carbon positive for 15 years, water positive for 18 years and solid waste recycling positive for 13 years.

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But does this really help offset the fact that it is still predominantly a tobacco company. “A company such as ITC has to do even better on the ESG score merely to offset the kind of business it operates in. If the ESG concern wasn’t such a big issue, why hasn’t the ITC stock rallied as much as some other stocks in 2020?" asks a senior mutual fund executive, requesting anonymity. Indeed, ITC’s shares are still about 15% lower vis-à-vis pre-covid highs seen in January.

Analysts from Motilal Oswal Financial Services Ltd said in a report on 8 December, “While ITC efforts on the overall ESG front are truly commendable, the concern over its cigarettes business from an ESG perspective remains at play – as more funds turn ESG-compliant (both globally and in India), affecting the valuations of global cigarette companies, including ITC."

Additionally, it’s not as if earnings outlook is bright. Motilal Oswal analysts point out, “The earnings growth outlook in the latter half of the last decade, considerably weakened v/s the former half, and ROEs saw a sharp decline (despite corporate tax cuts)." ROE is short for return on equity. “Profit before tax growth in the last five years has been about 6.6% and is likely to be around 7.3% in the next three years," the broking firm added.

Plus, with ITC, investors always have to worry about potential increase in cigarette taxes. “Double-digit cigarette tax hikes in FY22 remain a key risk," wrote analysts from Credit Suisse Securities (India) Pvt. Ltd in a report on 8 December.

Currently, a huge comforting factor about the ITC stock is its relatively lower valuations vis-a-vis other consumer stocks. Based on Bloomberg data, the shares currently trade at 16 times estimated earnings for financial year 2022. But as long as the ESG concerns remain, valuations can be expected to stay low.

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