To a layman, ITC appears to have its fingers in a lot of pies. It competes in tobacco, hotels, agri-business, packaging as well as FMCG, which is where the street is betting its money on. The maker of Gold Flake cigarettes also produces Aashirvaad Atta, Yippee noodles, Dark Fantasy Choco Fills and Savlon to name a few from its vast fast moving consumer goods (FMCG) product basket. But ITC’s stock declining more than 35% since 2017, has become a dilemma.

Investors have borne the brunt of higher taxation and slowing volumes of the cigarette business, amid the FMCG segment failing to fire on full cylinders. Even with double-digit YoY revenue growth in Q4FY21, the street remained unimpressed and ITC stock fell 3% after results were announced.

Quick Takes:

• ITC reported 14% YoY growth in cigarette revenues in March 2021 quarter with volumes touching pre-Covid levels

• The cigarette business contributed 85% to total earnings before interest & tax (EBIT) in Q4FY21, while ‘FMCG-others’ segment contributed  4.3%

• FMCG-others product portfolio is made up of product lines largely built ground up, with very few acquisitions such as Savlon and Shower to Shower (acquired from Johnson & Johnson)

• ITC launched 120 new FMCG products during FY21 to augment its revenue base

• Nearly 25-35% of capital expenditure (capex) every year since 2017-18 was allocated to ITC’s hotel business

March 2021 quarter’s revenues rise, but profitability disappoints

ITC is the market leader in the cigarette industry, with a presence in fast-moving consumer goods (FMCG), hotels, packaging and agriculture-related businesses (agri business). The company reported healthy Q4FY21 numbers with revenue growth of 23% YoY at Rs 13,295 crore compared to Rs 10,842 crore, a year ago. Revenue growth was driven by strong double-digit growth in four of its five segments - cigarettes, FMCG, paperboards and agri-business. The Hotels segment continued with its deceleration yet again in Q4FY21. Operating margins at 33.6% contracted 475 basis points (bps) YoY on account of higher cost of materials consumed, employee benefit expenses and excise duty (up 49% YoY). Total expenditure for the quarter increased 31% YoY. Consequently, net profit was lower at Rs 3,748 crore in March 2021 quarter falling 1.3%, YoY partly impacted by higher taxes. 

Agri & paperboards bring in positive growth, Hotels await rebound

Agri-business constituted 24% of total revenues in Q4FY21. Despite supply chain disruptions caused by the Covid-19 pandemic, the company leveraged its deep relationships with farmers built over the past two decades through the e-choupal network, to scale up direct farm purchases. Thus, ITC was able to ramp up huge volumes of wheat procurement substantially to cater to the surge in demand for Aashirvaad wheat flour in the early stages  of the pandemic.

Apart from fulfilling sourcing needs of the company’s foods business, ITC is the second largest exporter of agri products from India focusing on exports of soymeal, shrimps, prawns, frozen fruit products, coffee, pulses, rice and wheat. Except single digit growth in Q1FY21, agri-business revenues maintained double-digit growth throughout FY21. Agri-business reported 78% YoY revenue growth at Rs 3,368 crore in the March 2021 quarter. 

The paperboards & packaging segment was created to provide strategic backward integration for cigarettes business. The division supplies value-added packaging to ITC’s various FMCG businesses and also others like Tata Consumer Products’ Tata Tea, Colgate-Palmolive, British American Tobacco, Philip Morris International, UB Group, VST Industries, among others. After being in negative territory in the first three quarters, paperboards & packaging revenues returned to growth in double digits in Q4FY21. The segment reported 14% YoY growth and contributed 12% of total revenue mix. Exports, e-commerce, home care, packaged foods, personal care provided resilience, while discretionary segments such as liquor, tobacco, hosiery, footwear reported sluggish growth. The demand for writing and printing paper was also impacted due to closure of educational institutions and offices in the wake of the pandemic.

Hotels business contributed just 2% to the overall revenue mix in Q4FY21, with revenues falling 38% YoY to Rs 288 crore. The hospitality industry has been severely impacted by Covid-19 pandemic due to restrictions on travel and hotel operations. 

To combat an uncertain, disruptive business environment, several structural cost management measures were implemented across the value chain resulting in a 41% reduction in controllable fixed costs during the year. As a result, in spite of being the worst affected, hotel business reported sequential improvement in revenues every quarter. 

In the past, investors and analysts have often questioned ITC management’s capital allocation strategy for its hotels business. In fact, 25-35% of capex every year since 2017-18 was allocated to hotel business, largely known for its lower return on capital employed (ROCE). Though FY21 was deeply disrupted by Covid-19 leading to 57% YoY revenue fall, the hotel business’ revenues saw the highest CAGR of 10% from FY17-20 compared to all other business segments.

Cigarette & FMCG lag, failing to excite investors

The cigarette business reported 14% YoY revenue increase in March 2021 quarter at Rs 5,860 crore with volumes touching pre-Covid levels. ITC has more than 75% market share in the domestic cigarette industry generating huge cash flows year after year, providing a requisite source of funding for other business segments. 

ITC’s tobacco/cigarette business revenues are now stagnating, along with falling volumes. Governments all over the world have been disincentivizing tobacco usage by imposing punitive taxes and banning smoking in public places. In addition to heavy taxation, illegal cigarette volumes have increased several times over the years hurting players like ITC. Cigarette revenues for ITC declined 40% over the past five years from Rs 34,000 crore in FY17 to Rs 20,333 crore in FY21. In addition to the stagnating base of ITC’s mainstay business, FMCG-others segment is also not inspiring confidence. FMCG-others segment revenues at Rs 14,728 crore in FY21 grew at a CAGR of 9% over the past three years. This is lower than agri-business at Rs 12,582 crore in FY21 which grew at 16%. FMCG-others contributed 26% to total revenues in the March 2021 quarter reporting revenue growth of 16% YoY at Rs 3,687 crore. 

ITC ventured into the FMCG space in early 2000 and since then has entered various product categories, challenging market leaders. For instance, Yippee noodles have roughly 25% market share, while Sunfeast cream biscuits gave Britannia and Parle a run for their money, forcing them to launch innovative products. Classmate notebooks, Homelite matchsticks, Mangaldeep agarbatti, Dark Fantasy Choco Fills, Bingo are part of its superior brand line-up. 

But apart from Aashirvaad atta, no other product has been able to create a significant dent in their respective product categories. Unlike peers such as Hindustan Unilever which has a horde of brands sewn together through timely acquisitions, or Dabur’s iconic nine power brands, ITC is struggling within its product categories, trying to match up with market leaders. The company requires a cult brand such as Chyawanprash, Parachute hair oil, Maggi or Horlicks to rake in huge volumes and attain strong pricing power.

ITC has followed other FMCG players and launched 120 new products during FY21 to augment its revenue base. Though the revenue base improved, there has not been much increase in profitability levels. FMCG-others segment contributed 4.3% to total earnings before interest & tax (EBIT) in Q4FY21. On the other hand, cigarette business contribution to EBIT was a humongous 85% in March 2021 quarter. EBIT margin at 5% of FMCG-others segment is also too low compared to its peer group moving within a band of 16-22%. Even with slowing volumes, the cigarettes business continues to contribute a major chunk of EBIT while FMCG-others segment contribution hovers in the low single digits. It’s no surprise then that the ITC stock price has languished at 2013 levels, as its much-hyped FMCG business failed to live up to expectations. 

Bumpy road ahead for ITC– Acquisition might be the FMCG growth mantra

ITC’s agri-business is leveraging its e-choupal network, and exports are expected to log in positive growth in the upcoming June 2021 quarter. Packaging & paperboards segment growth will be impacted by April-May lockdown restrictions, lower discretionary consumption and closure of schools & colleges. 

For the hotel segment, the second wave of the pandemic has triggered a fresh round of mobility and travel restrictions leading to severe disruptions. The near-term outlook will depend largely on the return of consumer confidence in business and leisure travel. 

FMCG-others segment is expected to continue with its double-digit growth driven by staples, convenience foods and health & hygiene products. ITC acquired Sunrise Foods (spices) in July 2020 to strengthen its spice segment under Aashirvaad range of products. To compete with FMCG majors consolidated in Indian FMCG terrain, more such acquisitions are the need of the hour. 

And lastly we come to the cigarette business and its slowing growth trajectory. It’s hard for anyone to cheer for growth in the cigarette segment, and government efforts against smoking are expected to harden further, not slow. New Zealand plans to introduce a smoke free generation policy, banning smoking for people born after 2004. Though this might sound impractical in the Indian context, lawmakers are getting tough against cigarette companies all over the world. Back home, the Uttar Pradesh government has directed tobacco sellers to obtain licenses for selling tobacco products. In addition to this, tobacco sellers will not be able to sell other non-tobacco products. In case other state governments follow suit, it will be a tough ride for tobacco players like ITC.