Why ITC Isn’t Returning Analysts’ Love

Analysts have been smitten by ITC Ltd. for long, but this year that love has gone unrequited.Among consumer goods peers covered by at least 10 analysts, the cigarettes-to-hotels company is the most-preferred stock. According to Bloomberg data, 32 of the 37 brokerages tracking ITC recommend ‘Buy’. It’s trading at its cheapest valuation in nine years. And the average of 12-month target price estimates indicate a 25 percent upside—the best in the group.Yet, ITC is languishing with the worst-performing members when the NSE Nifty FMCG Index is trading about 1 percent higher and Nifty 50 is up 6 percent. No tax hike in two years, a reduced levy on hotel tariffs and a better-than-expected monsoon failed to perk up the stock..For the maker of Gold Flake cigarettes and Aashirvaad wheat flour, risks outweigh positives. Among the concerns is the worry that the government, struggling to bridge the budget gap, could increase the tax rate and even sell some of its holding in ITC. Weakness in its capital-intensive hotels business has weighed on the stock as well. And it comes on top of slowing consumption in the economy that has shrunk demand for makers of automobiles to biscuits, dragging growth down to its lowest in six years..Here’s what’s keeping ITC from breaking free:Potential For Higher TaxationSince the goods and services tax was rolled out in July 2017, the government didn’t increase taxes on cigarettes despite deteriorating fiscal and worsening GST collections. Yet, volume growth has been modest. ITC, however, maintained its operational performance on the back of steady hikes in cigarette prices..Still, the slowdown has started showing up in GST collections and may become a challenge for the Narendra Modi government to fulfill its promise of 14 percent increase in annual state revenues, according to CLSA, adding that the revenue from the compensation cess has been under pressure. “This may prompt the government to increase taxes on tobacco, which has seen no tax hike for over two years now.”Agreeing, G Chokkalingam, founder and head of Equinomics Research, said it’s only a matter of time before the government decides to lean on higher taxes from cigarettes.Non-Cigarette FMCG Business Yet To Pick UpITC’s staples-to-biscuits FMCG business, excluding cigarettes, has seen growth moderate from 11-12 percent in the year ended March to 8 percent in the first quarter of 2019-20, Kotak Institutional Securities said in a note, adding that it remained muted despite a “plethora of new launches”.The operating or EBIT margin of the FMCG Others segment remained low at 2.5 percent in the quarter ended June, unchanged from March, indicating little improvement in profitability.And like other FMCG peers that saw volume growth ease, the slowdown has hurt ITC as well.Hotels Weigh Down On ProfitabilityThe GST Council on Sept. 20 lowered tax rate from 28 percent to 18 percent for luxury hotels—rooms costing more than Rs 7,500 a day.ITC stands to gain as it only operates in the premium segment.Deepak Shenoy, founder of Capitalmind, however, said ITC’s hotels business is cyclical and eats up a lot of their capital, bringing down return-on-equity.While it weighs down on profitability, the business contributes not more than 4 percent to revenues, he said, taking away from the confidence that an FMCG company with known brands should command. “If they had a plan to separate out such (non-core) businesses, list them perhaps separately and create three or four units, then one could give a much higher valuation to ITC’s FMCG and cigarettes business.”.World’s Most Expensive Cigarette MakerITC trades at 20.6 times its one-year forward earnings, a nine-year low. Still, it’s the world’s most expensive listed tobacco company, trading at a premium of 46 percent to its next global peer Philip Morris International Inc. and 12 times the valuation of India peer Godfrey Phillips India Ltd..Government Stake Sale OverhangThe government, through its Specified Undertaking of Unit Trust of India, holds 8 percent stake in ITC. In January this year, newswire PTI reported citing an unnamed government official that the Modi administration is open to selling stake in ITC depending on valuations. If the government decides to exit or part-sell its stake amid fiscal worries, ITC’s stock price could get depressed, at least for a short period.Benefit From A Good Monsoon UncertainIndia’s southwest monsoon, which waters more than half of India’s farmland, ended “above normal” this year against the weatherman’s forecast of a 4 percent deficit. While that bodes well for consumption, especially in rural areas, it’s not sure how much will it help in a slowing economy.A good rainfall also aids the agri and paper businesses of ITC, but the two segments, according to filings for 2018-19, contribute 12 percent to ITC’s profit before tax.That’s not enough to offset other negatives.

Why ITC Isn’t Returning Analysts’ Love

ITC is languishing with the worst-performing FMCG stocks on Nifty, trading about 1 percent higher while Nifty 50 is up 6 percent.

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