ITC’s FMCG and paper businesses did well on the profit front
ITC’s FMCG and paper businesses did well on the profit front

Investors dismiss ITC’s high volume, low margin show as all smoke no fire

  • The cigarettes biz accounts for 85% of total profits; it isn’t surprising its performance is the biggest factor to drive the stock
  • The average annual returns in the past five years have been just 4.8% and the stock has underperformed peers by more than 20%

Cigarettes burn holes in your pocket, is a popular anti-smoking slogan. The same can be said about betting on ITC Ltd’s cigarettes business if you consider the performance of the company’s stock over the past five years.

The average annual returns in the past five years have been just 4.8% and the stock has underperformed peers by more than 20%. Things have progressively become worse. Compared to an average valuation discount of about 22% vis-à-vis other FMCG (fast-moving consumer goods) stocks in the past five years, ITC now trades at a 45% discount using the one-year forward price-earnings multiple, pointed out analysts at Jefferies India Pvt. Ltd.

The company’s December quarter results did little to assuage investor concerns. Cigarette volume growth rose to a seven-year high at 7.5%, but ITC shares fell more than 4% on Wednesday. Volume growth was impressive, notwithstanding the low base a year ago when volumes fell 5%, but the increase in business wasn’t accompanied by an improvement in margins. Cigarette margins fell 50 basis points year-on-year, which meant that profits of the segment again rose in single digits.

“In the cigarettes business, both volume growth and profit growth are important and this quarter there was good news on only one of them. The fact that decent volume growth in the cigarettes business did not translate into double-digit growth in earnings before interest and tax is a disappointment," said Abneesh Roy, senior vice president at Edelweiss Securities Ltd.

Sarvesh Kumar Sharma/Mint
Sarvesh Kumar Sharma/Mint


Price hikes have been muted and were insufficient to offset higher costs, as ITC was focused on getting back share from illegal cigarettes, according to Roy. The average realizations grew in the low-single digits. Higher tobacco leaf prices and higher capsule filter usage hurt margins in this segment, said analysts.

The cigarettes business accounts for around 85% of the company’s total profits and it isn’t surprising that its performance is the single biggest factor that drives the stock.

So, though ITC’s FMCG and paper businesses did well on the profit front, it didn’t matter much to investors. Profits of the FMCG business grew 63% year-on-year, while the paper business reported 24% growth in profits. However, the contribution of these segments to overall profits is small.

One of the main reasons growth in the cigarettes business has been sluggish in recent years is high taxation levels, with the imposition of the goods and services tax dealing another blow to the sector. Now, with the interim budget nearing, some investors are worried about negative surprises in store on the taxation front as early as February, if not in the full budget of the new government.

For a stock that is at the mercy of a fiscally constrained government, it is little wonder that it has underperformed peers.

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