ITC's appetite for staples grows as it moves away from tobacco

The company is betting on its non-cigarette FMCG portfolio to deliver growth and convince the markets that it is moving away from its tobacco dependence

ITC projects itself as a diversified conglomerate with a portfolio of cigarettes, hotels, agri-commodities, paperboards and specialty paper, and fast moving consumer goods. But the Street has rarely been convinced. With cigarettes accounting for 84 per cent of profit before interest and tax, ITC remains a tobacco play for the markets, and this is becoming a problem in two ways. 

In the past year, market returns on ITC stock have been minus 25.03 per cent. Over a two-year timeframe, the performance has been worse — minus 39.94 per cent — and over three years minus 32.7 per cent. That’s largely a result of ITC’s association with tobacco. 

At ITC’s annual general meeting last week, Chairman Sanjiv Puri admitted that the focus on ESG (environmental, social and governance) investing had created headwinds for tobacco stocks globally.

“This is despite the fact that we have a pretty good ESG rating,” he told shareholders, who raised concerns about the share price.

ITC’s annual report mentioned that it ranked first globally amongst peers (companies with market capitalisation between $38 billion and $51 billion) and overall third globally on ESG performance in the food products industry by Sustainalytics, a global ESG ratings company. It has also been rated “AA” by MSCI-ESG — the highest among global tobacco companies.

Cigarette companies globally are being screened out by ESG investors. ITC’s shareholding pattern filed with the Bombay Stock Exchange shows that since 2017, the holding of foreign portfolio investors — who have a significant sway over Indian equities — has come down from 19.99 per cent to 14.60 per cent.

But there are other worries with cigarettes that are weighing on ITC. Burdened with punitive taxation, the share of legal cigarettes is steadily falling and as market leader, ITC is losing volumes.

 

According to the Tobacco Institute of India (TII) July-August newsletter, taxes on cigarettes have more than trebled since 2012-2013. The goods and services tax (GST) regime introduced in July 2017 increased the tax burden on cigarettes by a weighted average of 13 per cent over pre-GST rates.

Thereafter, there was another sharp increase with the National Calamity Contingent Duty (NCCD) rates in the Union Budget 2020-2021. With taxation at these levels, illegal cigarettes now constitute about one-fourth of the market.

How is it impacting ITC? Abneesh Roy, executive vice president at Edelweiss Securities, said, “In a year marked by macroeconomic headwinds, prices have been increased by 10 per cent. That’s a double whammy. Additionally, though a low probability, there is always an overhang of GST rates being hiked.” 

On a compounded long-term average over the past 10 years, ITC’s cigarette volumes have been dropping 1-2 per cent on high taxation, he added.

The volume drop is showing in revenues. In FY17, revenues from cigarettes stood at Rs  35,878 crore and has progressively come down to Rs  23,679 crore in FY20. Profits, however, have grown during the same period, from Rs  13,204 crore in FY17 to Rs  15,838 crore in FY20, mainly due to successive price hikes.

Puri took charge as the chief executive officer in 2017; in 2018, he was re-designated managing director and effective May 2019, he became chairman.

ITC, however, had been preparing for headwinds in cigarettes for decades now, which is why it created multiple drivers of growth. Around 59 per cent of its revenues now come from the non-cigarettes business, of which the two-decade-old FMCG segment accounts for the largest chunk at around 22.5 per cent (revenues from non-cigarettes have grown from Rs  22,411 crore in FY17 to Rs  33,565 crore in FY20). 

The non-cigarettes FMCG business is now about half of the cigarettes business, clocking in revenues of more than Rs  12,875 crore in FY20; of this, foods would be more than Rs  10,000 crore, bringing it close to Britannia Industries, which had revenues of Rs  10,968 crore in FY19-20. 

Further, the Covid-19 pandemic gave the segment a fillip. Staples, convenience foods and health & hygiene products, which represent around 75 per cent of the portfolio, recorded a growth of 34 per cent. 

In keeping with consumer, ITC launched 40 products and variants during the pandemic; the Savlon portfolio grew five-fold compared to last year.

Overall, in the June quarter, revenues from the non-cigarettes FMCG segment grew 12.2 per cent on a comparable basis (excluding education and stationery products — which was impacted by deferment of academic session — it was up 18.8 per cent).

Puri has stayed focused on growing ITC profitably. Profits from the non-cigarettes FMCG segment in FY20 stood at Rs  425 crore while in the June quarter it was at Rs  125.41 crore; about three years back, in FY17, it was at Rs  26 crore.

But an analyst countered, ITC’s process of relying on building brands from scratch has made its growth in the segment a lengthy process, what could have been achieved faster inorganically. 

However, ITC recently acquired Sunrise — a 70-year-old brand with a dominant revenue share in West Bengal — for Rs  2,150 crore. In the past few years, the company also added brands like B-Natural, Savlon and Nimyle to its portfolio. 

With its investment cycle in infrastructure building now coming to an end, cash reserves will free-up for more acquisitions. 

A significant part of ITC’s capex — about Rs  3,000 crore a year — was on account of hotels. In the past four to five years, when peers adopted an asset-light strategy, ITC focused on building properties. The focus now is on following an asset-right strategy. 

Currently, 5,300 rooms of the 10,000-room portfolio are managed. About 4,000 rooms are under construction of which 3,000 will be under management contract. By the end of this phase next year, 8,300 rooms of a total of 14,000 rooms would be under such contracts. 

ITC also embarked on restructuring the cash-guzzling lifestyle retailing business last year. It sold the menswear brand John Players to Reliance Retail.

“Unless we have a specific idea on how we can win in this segment, we are not going to expand it or grow it,” Puri said recently. But ITC appears to have found a potentially winning idea in non-cigarettes FMCG and Puri is looking to make it a leader, not just in size, but in profitability, too.