What's cooking in ITC's kitchen that's made analysts bullish on the stock?

Analysts at Jefferies beleive the stock could top the Rs 600-mark, an upside of over 34 per cent from current levels

It has been a dream run for ITC stock in the past one year. The counter has surged 59 per cent as compared to 36 per cent rise in the Nifty FMCG index during this period. On Monday, the stock hit a fresh 52-week high on the NSE at Rs 465.95.

The bull-run in the stock, according to analysts, has been on account of the company's business verticals firing on all cylinders after remaining subdued for almost half a decade.

"ITC had not been growing much in the last 5 years. However, the company has done well in the last one year with all the business verticals gaining traction. Government's status quo on tax w.r.t. cigarettes has also helped. So overall, the growth has started improving, which was reflected in the stock price over the last few months," said AK Prabhakar, head of research at IDBI Capital.

At the fundamental level, Nomura suggests that ITC endeavors to outpace FMCG industry growth over the medium-term. Most of its FMCG categories, it said in a recent report, are generating positive free cash flow (FCF) and the businesses are no longer dependent on the cigarettes business' FCF for growth capex.

That apart, ITC's hotels business, it said, is witnessing strong improvement in average room rentals (ARR), with travel and tourism activities, including business and foreign inbound travel, back at pre-Covid levels. The brokerage maintained a 'buy' rating on the counter with a target price of Rs 485, with around 13 per cent EPS CAGR over FY23-25.

"FMCG margins are likely to improve structurally (around 80-100 basis points p.a.) over the medium-term on increase in scale of operations, premiumisation through new value-added launches and foray into newer adjacent fast-growing categories. There is no large capex planned for the hotels business, as ITC has moved to an asset right model. Current (hotel segment) margins are sustainable over the medium-term. Divestment of its hotels business is on the cards and the company is evaluating various alternate structures to ensure that the divestment is cost- and tax-effective," wrote Mihir P. Shah and Anshuman Singh of Nomura in a recent report.

The high capex and subpar return profile of the hotel business, according to analysts at Jefferies, has always been a concern for the investors. Over the last 20-years, it said, the average annual free cash flow (FCF) for this segment has been negative in the range of Rs 1.5 – 3 billion. Return on capital employed (RoCE) has also been in single-digits for most years, well below cost of capital.

In the last decade alone, the hotel business contributed less than 5 per cent of ITC revenues & Ebit, but accounted for over 20 per cent of ITC's capex, the Jefferies note said.

ITC entered into the hotel business in 1975 by acquiring a hotel in Chennai. With FY23 revenue / Ebitda of Rs 27 billion / Rs 8 billion, ITC now has an inventory of over 11,500 rooms across over 120 hotels in over 70 locations.

In their bull-case upside scenario, Jefferies expects around 13 per cent annual growth in cigarette EBIT over FY23-25E and nearly 14 per cent growth in FMCG revenues. Cigarette margins, it believes, are expected to expand by around 170 basis points (bps) over FY23-25E as increase in consumer prices more than offsets tax hikes.

"We use sum-of-the-parts (SOTP) methodology to value ITC cigarette business at 29x Mar-25 earnings, new FMCG at 6x Mar-25 sales, agri and paperboard businesses at 18x Mar-25 EPS, and hotels at 23x Mar-25 EV/ Ebitda to arrive at a (bull-case) price target of Rs 620," wrote Vivek Maheshwari, Kunal Shah and Jithin John of Jefferies in a June 27 note.