ITC: A value proposition

Suresh Krishnamurthy

Recommendation: The stock of ITC is trading at Rs. 778, at a price to earnings multiple of close to 20 times its annualised earnings for the first quarter of 2000-01. At the present price, the stock holds the potential to deliver attractive returns for the medium to long-term. A re-evaluation of the investment option may however be necessary if the company forays into the airlines industry.

Suitability: The risk associated with ITC may be higher compared to other FMCG stocks. This is because of the over-bearing impact of the government levies on the fortunes of the industry. However, the stock may still be an appropriate addition to any portfolio considering its near strangle-hold over the cigarette industry. Also, the defensive characteristics of the stock may be particularly useful to a portfolio invested largely in economically-sensitive stocks considering the recent slowdown in industrial activity.

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Key issues: With respect to ITC, the key issue has always been the reinvestment of the operational cash flows generated by the cigarette business. With operational cash flows amounting to over Rs. 1,000 crores per annum and the core business not requiring substantial additional investments, the reinvestment factor has assumed considerable significance.

In this backdrop, the recent announcement made by the company with respect to long-term investment plans is a positive factor. The company has identified information technology, retailing foods, greeting cards and sport equipments and accessories and hotels as the areas for investments.

The negative factor may be any proposed investment in the airlines industry through the Indian Government's disinvestment route. Any investment in the airlines industry may tend to be quite huge and may also weigh on cash flows and earnings for a considerable period of time. This would considerably alter the risk profile of the stock and a re-evaluation of the investment option may then be necessary.

Prospects: The medium-term prospect for ITC appears quite bright. The last few years have been difficult for the cigarette industry as a whole due to sizable increases in excise levies and State-level duties. In addition, select States have also imposed bans on public smoking. ITC has been able to weather the difficult period and has, in fact, added to its market share both in terms of volumes and value. This is reflected in the 20-25 per cent growth in profits reported by the company in the last two years.

Looking ahead, the sluggish growth in demand volumes appears destined to continue in next year as growth in agriculture sector is expected to decline. However, over the medium term, growth in demand is likely to keep pace with the growth in disposable income. Also, the changing product mix of ITC with a shift in favour of premium cigarettes augurs well for the company's profitability.