Rakshit Ranjan, Portfolio manager, Marcellus Investment Managers
ITC has strong competitive advantages in its cigarettes business due to raw material procurement, consistency of product quality, and a widespread distribution to over 10 million points of sale. This enables the firm to maintain 100% ROCE in the cigarettes business, while retaining its market share and delivering a healthy 12-14% EBIT CAGR for cigarettes. The company has also consistently passed on tax hikes. Thus, while ITC’s volume growth undergoes a temporary moderation during periods of penal tax hikes and vice versa, the firm’s pricing power ensures that revenue growth rates of the cigarettes business are not materially affected. Also, segments such as paper and agri have clearly generated healthy returns on capital employed. The stock is trading at a bigger discount (25-30%) on P/E multiples compared to the FMCG sector versus the historical average gap of 15-20% between ITC and the FMCG sector.
Sagarika Mukherjee, Vice president, Elara Capital
We are bearish on ITC because cigarette volumes have declined by 3% per annum over the past six years due to increasing number of consumers becoming more health conscious. The company’s pricing power is limited due to the steep increase in taxation since 2012, tripling in past six years. There has also been rampant growth of illegal cigarette industry in India, which offers almost 100% trade margins to the distributors or retailers. Also, the company’s cigarette business today is trading at price-to-earings ratio of 18x on December 2020 earnings which is in-line with its global peers who are under similar volume pressure. We believe that going forward, ITC will have to report mid single digit volume growth and will take a price hike in order to meet the expectations of >10% earnings growth in cigarettes. However, it has been unable to do so for some time now, hence the stock has been range bound for almost two years.