ITC thread on Valuepickr was started by Dhiraj Dave in March 2020 .
Key positive points highlighted by Mr Dave
Attractive valuation: At current price of Rs 160 (19 March 2020), the company is trading at lower than April 2012 close of 163 (31 times PE). From FY12-FY19
Among most productive distribution
Ability to Build World Class Scaleable Brands :
High Rating on ESG : Carbon and Water Positive & Solid waste Positive
Giant Sustainable Cash GeneratingMachine
-ve Points as highlighted by Mr Dave
1) Adverse capital allotment
Capital allocation to Hotel business is neglible 3% in FY19 and FMCG-other segment is around 6% in FY19. The ROCE of Agri business and Paper business are moderate at around 20%+ in FY19, still much inferior to Cigarette busniess.
2)Higher Management Compensation
Liberal stock options right from 2005 to 2019 led to significant equity dilution over long period of time .. 4000 crores worth ESOP led compensation was rewarded in this time frame and employee contributed 19000 crores + for the same ..
I will give you few examples then you will understand what Agri supply chain means
echoupal procures over 2 million tons of wheat every year … No one private players procures even 1/10 of this quantity …
There are over 200 varieties of wheat - What Koltatta likes is different from what Hyderabad or New Delhi likes … ITC creates blends of wheat from these 200 varieties so that each area …
ITC creates Wheat Seed Relevant bank so that MP wheat can be grown in Rajasthan so that if there is crop failure in MP still supply chain is not impacted …
Rest all including Patanjali buys wheat from traders at large market like Delhi, Kota , Indore etc which are Mixed wheat without origin so you cannot create unique Atta blends to cater to different tastes …
ITC is one of largest wheat and now Maida supplier , plus one of largest wheat exporter .
In coffee it supplies coffee to international brands like Lavassa , Nescafe and many more …
Similarly it has large Natural Mango and other fruit juice processing centers many of which are certified have organic certification - for export to Europe - It is also one the largest in India
eChoupal has Potato seed plant and is largest supplier of seed in India and it also export the same - It supplies these seed to even lays for their contract farming …
These supply chain generates very high T/o and profits on standalone basis … Look at Agri business Profits and ROCE
While history does not repeat itself, but it make sense to know history of the company, particularly with company like ITC which has all the issue of management having all power with limited responsibility. While on various blogs and threads, there are various concerns being presented and discussed on this thread, which is perfectly fine. However, one need to be clear about investment what it expect from portfolio?
ITC has been of very few company which has remain large in size and shown moderate growth over lifecycle. The way I look at ITC is allocation to fixed income portion of financial investment with having very long equity option which may provide huge upside or may result in nil valuation at end. We all, including experts on blog would know about the outcome only in future. So no point on analysis and trying to forecast future for all of us.
My summary of thoughts:
Can ITC sustain dividend of around Rs 9-10 over next 8-10 years? In my view, probability of same is more than 50%. Hence, it take care of fixed income interest portion for me.
Second point, in fixed income, I have certainity of principal repayment while in equity I may suffer loss. Having said that, most investor in fixed income (excluding G-Sec and AAA Corporate) are significantly leveraged (I refer to financial sector like Bank/NBFC). I find equity value in ITC has better chance then leveraged institution. We all know problem of ILFS/DHFL/Rel Cap bond investors. In my limited understanding, while Cigarette business is likely to be cash-cow for next 8-10 years, FMCG others could provide growth. This may be biased view and my track record of forecasting is pathetic at best (Please refer to Shemaroo and Care Rating where I made big mistake beside Arrow Greentech). But investing is also involve taking call based on once comfort and invest, I definitely find Nestle ad HLL being better at capital allocation, but the price do not provide any support in my limited understanding. I have already shared my wokring of 50 years return on ITC.
I would also like to look at investor in HLL (return from 1999-2009) or Reliance Industries (from 2008-2018 period.) There was virtually no movement in price for almost decade. 2012-2022 may be ITC’s lost decade.
However, decision to provide 80% of cashflow to return broadly provide limited scope for management to misallocate the capital. The product they manufacture are also among the best in quality. This is again may be subjective view but I find that ITC has compromised probably on profitability to provide superior quality to customer and that itself can provide big competitive advantage over a very long period.
Putting all positive, still ESG related concern and overhang of supply from SUUTI may continue to put downward pressure on price. However, I would wait for time to provide final verdict rather jumping to conclusion. Having said that, I have already taken leap of faith and allocated 10% of equity portfolio to ITC. Reader shall take note of this while reading this thread. As Krishna say, we are entitle to karma (i.e. to decide to invest or not), the fruit of karma is not in our control. After my working and analysis, I have executed on my side, the final outcome would be known only after 5-10 years.
Lets look at ITC approach to procurement and share services
ITC infotech - is Internal IT department which caters to external customers so that it is self sufficient . Hence it is not a cost center per say . Cannot compare with Infosys
ITC agri business : It is RM procurement department for tobacco and Food business … but services external customers so that it is profit centre and not cost centre . Cannot compare with Global Agro commodities majors like Cargill
ITC Paper and packaging Department is multilevel packaging department of ITC … which focus on paper packaging again cannot be compared with Global Packaging major in the world
ITC builds its own factories , hotels , employee housing complex , Retail stores, warehouses … but cannot be compared to even likes of Oberoi Realty …
Earlier it did vegetable retailing , selling clothes and many other stuff
Now why does Corporate ITC does so many services which it can outsource –
Because ITC is like Fund house that funds ideas - any idea that can earn it > 10% yield better than liquid fund + 4% or inflation +4% … it does that activity …
This not typical of FMCG companies which tend to outsource all their activities other than core branding , marketing …
Indian FMCG companies outsource production to OPC , R&D to MNC Parent , Warehousing and other services to Warehouse providers and Procurement to companies like ITC – Yes there are times when Britannia buys wheat from ITC
I have attempted to do a deep dive into the Indian Cigarette Industry from an equity valuation perspective. The reason for doing is that when I was attempting to project revenue growth of Indian Cigarette companies such as ITC, VST I wanted an understanding into the drivers affecting Indian Cigarette consumption but could not find any comprehensive article or report. Thus, I read equity research reports, filings of listed companies, WHO reports, several studies analyzing tobacco usage in India, etc and thereafter aspire to share with you’ll the relevant information in a coherent and succinct manner. The information is by no means comprehensive and a Cigarette industry insider can accuse me of being “Captain Obvious”. However, having come across many ITC/VST investors who have limited knowledge of the Cigarette Industry (as I did prior to commencing my research), it is my sincere hope that this information can increase their knowledge to atleast a certain basic level in the shortest time possible. I hope that this information can aid an investor in making their own projections and/or evaluate the validity & possibility of Cigarette revenue projections made by analysts.
With the introduction out of the way, the key factors to consider while evaluating Cigarette consumption in India are:
1) Cigarette consumption is only 4% in India as compared to 25% in China or 28% in Europe. However, can this fact be extrapolated to assume that Indian Cigarette market has huge growth potential? Not by a long shot. This is because not only does the Indian consumer has several options to get his/her tobacco fix but also these alternate options are substantially cheaper than Cigarettes
As per the GATS-2 survey tobacco usage in India is 28.6% and thereby is higher than most countries. However, tobacco usage in India is very different from other parts of the world. Smokeless tobacco is twice as popular as smoking tobacco. Even within smoking tobacco, bidis are twice as popular as Cigarettes. Cigarettes are only 14% of the total tobacco consumption. Thus, an assumption that the Indian cigarette industry has a long growth ahead, simply because of lower percentage use of Cigarettes compared to other countries, cannot be sustained.
2) Cigarettes are around 3.5x price of bidis and around 11-12x price of Chewing Tobacco.
Cigarettes are extremely expensive compared to other Tobacco products. Because of the sheer price difference between the tobacco products, switching to Cigarettes from Chewing Tobacco or Bid involves a huge monetary impact and thus its not easy for a Cigarette company to “up-sell” and convert a bidi/tobacco user. One can also argue that the refinement of a Cigarette cannot be compared to a bidi (or the social nuisance of chewing tobacco) just the way you cannot compare a country liquor with a single malt whisky (even after adjusting for alcohol content). This is a fair point.
However, the idea in this point and in the previous point no.1 is to show that the Indian consumer has several tobacco products (available at a variety of price points) to choose from and such variety in tobacco products is not so prevalent in most of the other countries and thereby projecting growth rates in cigarettes based on other countries and/or assuming that Cigarette companies can easily “up-sell” their Cigarettes is seriously flawed.
3) Can cigarettes be taxed higher?
Before this question can be answered, the following questions must be considered:
a) How much have Cigarette prices increased over the years?
Various studies inform us that cigarette and bidi real prices increased about 3% and 3.70% respectively on a yearly CAGR basis from 2000 to 2018. However, at the same GDP/capita increased much faster. That means cigarettes and bidis take a smaller portion of our wallet now as compared to what they did in the year 2000. Cigarettes have actually become CHEAPER by 20% (and bidis by 30%) when compared to that in the year 2000!
b) What are the tax rates on Cigarettes in other countries?
India has a tax rate of 56% for the year of 2018. While there has been further increase in taxes in India after 2018, the tax rate on Cigarettes is less than that of many countries as can be seen in the chart below
Furthermore, WHO recommends that the taxes should be at least 70% of the retail price. However, despite their inclusion in the GST demerit list of highest tax slab and even after accounting for the recent increases, taxes on tobacco products are still below the WHO recommendation.
Now, when the information presented in 3a and 3b are looked together, it is rather unlikely that taxes on cigarette will reduce. On the contrary, there is every chance that it may increase further. Unlike most investors I hope that now, with this background in mind, you will not be surprised if & when the Government increases their taxes on Tobacco.
4) Tobacco use has been declining in India
a) Various study have noted that over the past three decades, the prevalence of smoking has declined steeply and consistently. Smokeless Tobacco, after seeing an initial rise, has also declined but by a lesser magnitude. The GATS-2 survey (conducted in 2016-17) shows decline in tobacco use as compared to that prevalent during the GATS-1 survey (during 2009-10)
b) Furthermore, under the National Health Policy 2017, the Indian Government has set a target for reduction of 30% (from 2010 levels) by the year 2025 . Thus, it is highly unlikely that there will be relaxation in Government policies towards tobacco.
c) Market Data
The combined Cigarette volumes of ITC Ltd (the largest cigarette manufacturer in India) and that of VST Industries Ltd (a manufacturer of “value” cigarettes) have not grown in the past decade. As per various equity research reports published by ICICI Direct and HDFC Securities
CONCLUSION
Based on the above, as of today, it is my view that the revenue growth in Cigarettes is very unlikely to come from any significant volume growth and instead the companies will have to primarily rely upon price increases for increasing revenue. Price increases, as we have seen, can increase revenue but only up to a certain point as beyond that, the consumption will fall. Furthermore, price increases have to be shared with the Government in the form of GST and cesses. Hence, one must be extremely vary of making any strong revenue growth projections for Indian Cigarette companies. Is strong volume growth possible? Sure, but the question to ask is how likely is it? It is my view that investing is a game of probabilities and therefore less likely outcomes should not be modelled while projecting revenues.
Needless to say that if the underlying factors change then my view will (and should!) change.
The various studies, charts, graphs, etc referred to above are duly linked and referenced in a more detailed article published on my blog.
Let us go through ITC historical performance other than its share price.
Dividend CAGR:
2016 - 2020 - 14.6%
2011 - 2020 - 15.6%
2000 - 2020 - 22.8%
*(Dividend(incl. DDT) / PAT: 2000 - 28.3%, 2011 - 80%, 2016 - 83%, 2020 - 81.5%). Above Dividend CAGR calculation does not include effect of DDT, which has been removed from this year.
Financial assets of company:
2010 - 4452 Cr in Bonds & MF + 1347 Cr Cash & Bank balance = 5799 Cr
2020 - 27730 Cr in Bonds & MF + 7277 Cr Cash & Bank balance = 35007 Cr
19.69% CAGR in above mentioned Financial assets.
Only somewhat negative which I could find out was that ROCE is consistently declining since 2015. But, I think we all know the reason for this. They are in investment mode in last decade which has yet to generate sufficient return and its not possible for FMCG & Others business to generate the ROCE similar to cigarettes.
Despite all these investments in hotels, FMCG & others, their last 10 year dividend CAGR is 15%+ and they have increased financial assets 6 times. Also, as they have now stopped large investments in hotels, most of the investments related to ICML will be over soon and with time FMCG & others will start contributing their bit, i think ROCE will move upwards.
*Apologies. I missed the bonus issues of ITC in year 2005 & 2010 in previous 2000-2020 Dividend CAGR calculation. Please see the updated value.
HUL’s Annapurna was the 1st entrant into branded Atta space way back in 1998, which otherwise was a large unorganized space. General Mills followed by launching Pillsbury, both together owned nearly 100% of the organized market which was growing at high double digits. Then came ITC’s #Aashirvaad that changed the game of the industry. ITC took a lion’s share from the incumbent players – by 2010, Pillsburry got sidelined & Annapurna was struggling to gain share back .HUL did a re-launch of Annapurna with a new packaging but failed again & by 2016 appointed I-bankers to exit out of the category. ITC currently has about 6 different variants of Aashirvaad & ~30% of branded Atta market in India which valued at about 16,000 Cr INR
Instant Noodles:
Nestle literally ruled instant noodle mkt for years - since its launch in India in 1982, #Maggi had become a synonym for noodles across households & age groups – it was hard to even think of launching a brand to compete against Maggi . While Maggi faced some competition from contemporary brands in late 90’s, by early 2000s it grabbed back its lost share! ITC came in with #Yippee at a time when Maggi had over 90% market share.While the share gain by Yippee was slow & steady, the controversy & ban of Maggi in 2015 helped ITC fast track this. Currently Yippee is the 2nd largest player with nearly 25% share & growing!
Chips:
Packaged snacks / Potato chips was a market dominated by Pepsico [Frito Lay] with over 80% share who was also the first entrant into branded packaged snacks, since 1995. ITC entered the market in 2005. . Fast forward 2018, ITC has about 16% share in overall packages snacks [roughly 23,000 Cr) and around 27% share in bridge” or finger snacks [Kurkure vs Bingo Mad Angles / Tedhe Medhe] and about 8% in potato chips
Biscuits
Britannia and Parle together had over 85% share in the market followed by other smaller players at 15%. Both had a strong legacy & brand equity in customer minds & was not an easy task to break into that space.Fast fwd 2018 ITC dominates the cream biscuits mkt with roughly 25% share & about 12% in the overall business market which is roughly 35,000 Cr in India.
Antiseptic / Hand Hygiene:
Dettol had over 85% share in 2015, which is when ITC acquired #Savlon from J&J. Again, fighting a giant with a near monopoly . Dettol was roughly 800 Cr brand in 2015, when Savlon was ~65 Cr. Fast forward 2020 -Salvon consumer spend exceed Rs 1000 crores
Several new variants were introduced during the year to cater to the continuously evolving consumer preference and ensure the future readiness of the Company’s product portfolio. Key market interventions during the year include the launch of innovative and differentiated offerings at the premium end such as Gold Flake Indie Mint & Gold Flake Luxury and the extension of Gold Flake Neo & Classic Rich & Smooth to other markets. The Business also deployed focused offers under the ‘American Club’, ‘Wave’, ‘Player’s Gold Leaf’, ‘Pall Mall’, ‘Navy Cut’, and ‘Flake’ trademarks in strategic markets towards bolstering and strengthening its market standing.
It is pertinent to note that since 2016-17 i.e. pre-GST, taxes on cigarettes have increased by 40%, i.e. at a compound annual growth rate (CAGR) of about 12% (on a comparable basis) - over thrice the rate of inflation during the same period.
Discriminatory taxation on cigarettes, has caused progressive migration from consumption of duty- paid cigarettes to other lightly taxed/tax-evaded forms of tobacco products, comprising illegal cigarettes and bidi, chewing tobacco, Gurkha, Zarda, snuff, etc. Consequently, while the share of legal cigarettes in total tobacco consumption in the country has declined considerably from 21% in 1981- 82 to a mere 9% (against global average of 90%), aggregate tobacco consumption has increased over the same period.
Illicit cigarette trade in the country has been growing at an alarming rate. Euromonitor International ranks India as the 4th largest illicit cigarette market globally.
While legal cigarette industry volumes have declined by about 20% between 2010/11 and 2019/ 20, the illicit duty-evaded cigarette segment has grown by 36% during the same period , accounting for about one-fourth of the domestic industry and making India one of the fastest growing illicit cigarette markets in the world.
The regulatory framework for cigarettes in the country is one of the strictest in the world.
The large and rapidly growing illicit cigarette trade also has a deleterious impact on the millions of farmers and farm workers engaged in the tobacco value chain. Since smuggled international brands of cigarettes do not use Indian tobaccos, in addition to revenue losses, the growth of the illegal cigarette trade has also resulted in a severe drop in demand for Indian FCV tobaccos in the domestic market.
It is pertinent to note that several other major tobacco producing countries, including the USA have framed regulatory frameworks for tobacco taking into consideration the economic interests of their tobacco farmers. The inadvertent and unforeseen consequence of the stringent Indian tobacco regulations and discriminatory taxation continues to adversely impact the livelihood of Indian tobacco farmers with corresponding gains to tobacco farmers in the countries that have opted for moderate and equitable tobacco regulations.
It is estimated that since 2013-14, Indian tobacco farmers have suffered a cumulative drop in earnings of appx. Rs.5,175 crore
Stability in taxes on cigarettes will have the salutary effect of enabling the legal cigarette industry to claw back volumes thereby engendering domestic demand for Indian tobaccos. This will also help cushion the impact of volatility in international markets.
ITC has acquired a 100% stake in Kolkata based Sunrise Food Pvt Ltd. The company is in the business of basic & blended spices and mustard oil with the brand name ‘Sunrise’. Sunrise brand has a ~| 1000 crore sales in FY20 while the deal size is ~| 1800-2000 crore. The company is largely present in eastern India and operates through four factories in Agra, Bikaner, Jaipur and Kolkata. ITC is also present in spices business under Aashirvaad brand and is a leader in Telangana, Andhra Pradesh markets. The acquisition will help increase penetration of the Sunrise brand across the country while leveraging ITC’s wide distribution network.
Few points which I think we can add to your note for completion:
BAT has voted against the ESOP policy (they don’t want their stake getting diluted) so going forward there will be no ESOP. Also ITC may not want to increase BATs stake, so no buyback in the future should be expected.
SUUTI stake sale overhang - around 8% holding they have of ITC
Oct 2020 : kb_snn (Shailesh )
I will give you few examples then you will understand what Agri supply chain means
echoupal procures over 2 million tons of wheat every year … No one private players procures even 1/10 of this quantity …
There are over 200 varieties of wheat - What Koltatta likes is different from what Hyderabad or New Delhi likes … ITC creates blends of wheat from these 200 varieties so that each area …
ITC creates Wheat Seed Relevant bank so that MP wheat can be grown in Rajasthan so that if there is crop failure in MP still supply chain is not impacted …
Rest all including Patanjali buys wheat from traders at large market like Delhi, Kota , Indore etc which are Mixed wheat without origin so you cannot create unique Atta blends to cater to different tastes …
ITC is one of largest wheat and now Maida supplier , plus one of largest wheat exporter .
In coffee it supplies coffee to international brands like Lavassa , Nescafe and many more …
Similarly it has large Natural Mango and other fruit juice processing centers many of which are certified have organic certification - for export to Europe - It is also one the largest in India
eChoupal has Potato seed plant and is largest supplier of seed in India and it also export the same - It supplies these seed to even lays for their contract farming …
These supply chain generates very high T/o and profits on standalone basis … Look at Agri business Profits and ROCE
Oct 2020 : dd1474 Collaborator
While history does not repeat itself, but it make sense to know history of the company, particularly with company like ITC which has all the issue of management having all power with limited responsibility. While on various blogs and threads, there are various concerns being presented and discussed on this thread, which is perfectly fine. However, one need to be clear about investment what it expect from portfolio?
ITC has been of very few company which has remain large in size and shown moderate growth over lifecycle. The way I look at ITC is allocation to fixed income portion of financial investment with having very long equity option which may provide huge upside or may result in nil valuation at end. We all, including experts on blog would know about the outcome only in future. So no point on analysis and trying to forecast future for all of us.
My summary of thoughts:
Can ITC sustain dividend of around Rs 9-10 over next 8-10 years? In my view, probability of same is more than 50%. Hence, it take care of fixed income interest portion for me.
Second point, in fixed income, I have certainity of principal repayment while in equity I may suffer loss. Having said that, most investor in fixed income (excluding G-Sec and AAA Corporate) are significantly leveraged (I refer to financial sector like Bank/NBFC). I find equity value in ITC has better chance then leveraged institution. We all know problem of ILFS/DHFL/Rel Cap bond investors. In my limited understanding, while Cigarette business is likely to be cash-cow for next 8-10 years, FMCG others could provide growth. This may be biased view and my track record of forecasting is pathetic at best (Please refer to Shemaroo and Care Rating where I made big mistake beside Arrow Greentech). But investing is also involve taking call based on once comfort and invest, I definitely find Nestle ad HLL being better at capital allocation, but the price do not provide any support in my limited understanding. I have already shared my wokring of 50 years return on ITC.
I would also like to look at investor in HLL (return from 1999-2009) or Reliance Industries (from 2008-2018 period.) There was virtually no movement in price for almost decade. 2012-2022 may be ITC’s lost decade.
However, decision to provide 80% of cashflow to return broadly provide limited scope for management to misallocate the capital. The product they manufacture are also among the best in quality. This is again may be subjective view but I find that ITC has compromised probably on profitability to provide superior quality to customer and that itself can provide big competitive advantage over a very long period.
Putting all positive, still ESG related concern and overhang of supply from SUUTI may continue to put downward pressure on price. However, I would wait for time to provide final verdict rather jumping to conclusion. Having said that, I have already taken leap of faith and allocated 10% of equity portfolio to ITC. Reader shall take note of this while reading this thread. As Krishna say, we are entitle to karma (i.e. to decide to invest or not), the fruit of karma is not in our control. After my working and analysis, I have executed on my side, the final outcome would be known only after 5-10 years.
Oct 2020 kb_snn ( Shailesh )
Lets look at ITC approach to procurement and share services
ITC infotech - is Internal IT department which caters to external customers so that it is self sufficient . Hence it is not a cost center per say . Cannot compare with Infosys
ITC agri business : It is RM procurement department for tobacco and Food business … but services external customers so that it is profit centre and not cost centre . Cannot compare with Global Agro commodities majors like Cargill
ITC Paper and packaging Department is multilevel packaging department of ITC … which focus on paper packaging again cannot be compared with Global Packaging major in the world
ITC builds its own factories , hotels , employee housing complex , Retail stores, warehouses … but cannot be compared to even likes of Oberoi Realty …
++ taxi services , Tour operator , laundry services , Restaurants ,
Earlier it did vegetable retailing , selling clothes and many other stuff
Now why does Corporate ITC does so many services which it can outsource –
Because ITC is like Fund house that funds ideas - any idea that can earn it > 10% yield better than liquid fund + 4% or inflation +4% … it does that activity …
This not typical of FMCG companies which tend to outsource all their activities other than core branding , marketing …
Indian FMCG companies outsource production to OPC , R&D to MNC Parent , Warehousing and other services to Warehouse providers and Procurement to companies like ITC – Yes there are times when Britannia buys wheat from ITC
Sept 2020 : Anmol 2021
Hi everyone,
I have attempted to do a deep dive into the Indian Cigarette Industry from an equity valuation perspective. The reason for doing is that when I was attempting to project revenue growth of Indian Cigarette companies such as ITC, VST I wanted an understanding into the drivers affecting Indian Cigarette consumption but could not find any comprehensive article or report. Thus, I read equity research reports, filings of listed companies, WHO reports, several studies analyzing tobacco usage in India, etc and thereafter aspire to share with you’ll the relevant information in a coherent and succinct manner. The information is by no means comprehensive and a Cigarette industry insider can accuse me of being “Captain Obvious”. However, having come across many ITC/VST investors who have limited knowledge of the Cigarette Industry (as I did prior to commencing my research), it is my sincere hope that this information can increase their knowledge to atleast a certain basic level in the shortest time possible. I hope that this information can aid an investor in making their own projections and/or evaluate the validity & possibility of Cigarette revenue projections made by analysts.
With the introduction out of the way, the key factors to consider while evaluating Cigarette consumption in India are:
1) Cigarette consumption is only 4% in India as compared to 25% in China or 28% in Europe. However, can this fact be extrapolated to assume that Indian Cigarette market has huge growth potential? Not by a long shot. This is because not only does the Indian consumer has several options to get his/her tobacco fix but also these alternate options are substantially cheaper than Cigarettes
As per the GATS-2 survey tobacco usage in India is 28.6% and thereby is higher than most countries. However, tobacco usage in India is very different from other parts of the world. Smokeless tobacco is twice as popular as smoking tobacco. Even within smoking tobacco, bidis are twice as popular as Cigarettes. Cigarettes are only 14% of the total tobacco consumption. Thus, an assumption that the Indian cigarette industry has a long growth ahead, simply because of lower percentage use of Cigarettes compared to other countries, cannot be sustained.
2) Cigarettes are around 3.5x price of bidis and around 11-12x price of Chewing Tobacco.
Cigarettes are extremely expensive compared to other Tobacco products. Because of the sheer price difference between the tobacco products, switching to Cigarettes from Chewing Tobacco or Bid involves a huge monetary impact and thus its not easy for a Cigarette company to “up-sell” and convert a bidi/tobacco user. One can also argue that the refinement of a Cigarette cannot be compared to a bidi (or the social nuisance of chewing tobacco) just the way you cannot compare a country liquor with a single malt whisky (even after adjusting for alcohol content). This is a fair point.
However, the idea in this point and in the previous point no.1 is to show that the Indian consumer has several tobacco products (available at a variety of price points) to choose from and such variety in tobacco products is not so prevalent in most of the other countries and thereby projecting growth rates in cigarettes based on other countries and/or assuming that Cigarette companies can easily “up-sell” their Cigarettes is seriously flawed.
3) Can cigarettes be taxed higher?
Before this question can be answered, the following questions must be considered:
a) How much have Cigarette prices increased over the years?
Various studies inform us that cigarette and bidi real prices increased about 3% and 3.70% respectively on a yearly CAGR basis from 2000 to 2018. However, at the same GDP/capita increased much faster. That means cigarettes and bidis take a smaller portion of our wallet now as compared to what they did in the year 2000. Cigarettes have actually become CHEAPER by 20% (and bidis by 30%) when compared to that in the year 2000!
b) What are the tax rates on Cigarettes in other countries?
India has a tax rate of 56% for the year of 2018. While there has been further increase in taxes in India after 2018, the tax rate on Cigarettes is less than that of many countries as can be seen in the chart below
Furthermore, WHO recommends that the taxes should be at least 70% of the retail price. However, despite their inclusion in the GST demerit list of highest tax slab and even after accounting for the recent increases, taxes on tobacco products are still below the WHO recommendation.
Now, when the information presented in 3a and 3b are looked together, it is rather unlikely that taxes on cigarette will reduce. On the contrary, there is every chance that it may increase further. Unlike most investors I hope that now, with this background in mind, you will not be surprised if & when the Government increases their taxes on Tobacco.
4) Tobacco use has been declining in India
a) Various study have noted that over the past three decades, the prevalence of smoking has declined steeply and consistently. Smokeless Tobacco, after seeing an initial rise, has also declined but by a lesser magnitude. The GATS-2 survey (conducted in 2016-17) shows decline in tobacco use as compared to that prevalent during the GATS-1 survey (during 2009-10)
b) Furthermore, under the National Health Policy 2017, the Indian Government has set a target for reduction of 30% (from 2010 levels) by the year 2025 . Thus, it is highly unlikely that there will be relaxation in Government policies towards tobacco.
c) Market Data
The combined Cigarette volumes of ITC Ltd (the largest cigarette manufacturer in India) and that of VST Industries Ltd (a manufacturer of “value” cigarettes) have not grown in the past decade. As per various equity research reports published by ICICI Direct and HDFC Securities
CONCLUSION
Based on the above, as of today, it is my view that the revenue growth in Cigarettes is very unlikely to come from any significant volume growth and instead the companies will have to primarily rely upon price increases for increasing revenue. Price increases, as we have seen, can increase revenue but only up to a certain point as beyond that, the consumption will fall. Furthermore, price increases have to be shared with the Government in the form of GST and cesses. Hence, one must be extremely vary of making any strong revenue growth projections for Indian Cigarette companies. Is strong volume growth possible? Sure, but the question to ask is how likely is it? It is my view that investing is a game of probabilities and therefore less likely outcomes should not be modelled while projecting revenues.
Needless to say that if the underlying factors change then my view will (and should!) change.
The various studies, charts, graphs, etc referred to above are duly linked and referenced in a more detailed article published on my blog.
Note, the usual disclaimers apply
Sept 2020 Pankaj Yadav
Let us go through ITC historical performance other than its share price.
Dividend CAGR:
2016 - 2020 - 14.6%
2011 - 2020 - 15.6%
2000 - 2020 - 22.8%
*(Dividend(incl. DDT) / PAT: 2000 - 28.3%, 2011 - 80%, 2016 - 83%, 2020 - 81.5%). Above Dividend CAGR calculation does not include effect of DDT, which has been removed from this year.
Financial assets of company:
2010 - 4452 Cr in Bonds & MF + 1347 Cr Cash & Bank balance = 5799 Cr
2020 - 27730 Cr in Bonds & MF + 7277 Cr Cash & Bank balance = 35007 Cr
19.69% CAGR in above mentioned Financial assets.
Only somewhat negative which I could find out was that ROCE is consistently declining since 2015. But, I think we all know the reason for this. They are in investment mode in last decade which has yet to generate sufficient return and its not possible for FMCG & Others business to generate the ROCE similar to cigarettes.
Despite all these investments in hotels, FMCG & others, their last 10 year dividend CAGR is 15%+ and they have increased financial assets 6 times. Also, as they have now stopped large investments in hotels, most of the investments related to ICML will be over soon and with time FMCG & others will start contributing their bit, i think ROCE will move upwards.
*Apologies. I missed the bonus issues of ITC in year 2005 & 2010 in previous 2000-2020 Dividend CAGR calculation. Please see the updated value.
Sept 2020 J Joy
ITC Limited - 109th Annual General Meeting
https://www.itcportal.com/about-itc/ChairmanSpeakContent.aspx?id=2318&type=B&news=2020
June 2020 : Prashant Pandarathil
ITC : How they penetrate monopolies
Atta:
HUL’s Annapurna was the 1st entrant into branded Atta space way back in 1998, which otherwise was a large unorganized space. General Mills followed by launching Pillsbury, both together owned nearly 100% of the organized market which was growing at high double digits. Then came ITC’s #Aashirvaad that changed the game of the industry. ITC took a lion’s share from the incumbent players – by 2010, Pillsburry got sidelined & Annapurna was struggling to gain share back .HUL did a re-launch of Annapurna with a new packaging but failed again & by 2016 appointed I-bankers to exit out of the category. ITC currently has about 6 different variants of Aashirvaad & ~30% of branded Atta market in India which valued at about 16,000 Cr INR
Instant Noodles:
Nestle literally ruled instant noodle mkt for years - since its launch in India in 1982, #Maggi had become a synonym for noodles across households & age groups – it was hard to even think of launching a brand to compete against Maggi . While Maggi faced some competition from contemporary brands in late 90’s, by early 2000s it grabbed back its lost share! ITC came in with #Yippee at a time when Maggi had over 90% market share.While the share gain by Yippee was slow & steady, the controversy & ban of Maggi in 2015 helped ITC fast track this. Currently Yippee is the 2nd largest player with nearly 25% share & growing!
Chips:
Packaged snacks / Potato chips was a market dominated by Pepsico [Frito Lay] with over 80% share who was also the first entrant into branded packaged snacks, since 1995. ITC entered the market in 2005. . Fast forward 2018, ITC has about 16% share in overall packages snacks [roughly 23,000 Cr) and around 27% share in bridge” or finger snacks [Kurkure vs Bingo Mad Angles / Tedhe Medhe] and about 8% in potato chips
Biscuits
Britannia and Parle together had over 85% share in the market followed by other smaller players at 15%. Both had a strong legacy & brand equity in customer minds & was not an easy task to break into that space.Fast fwd 2018 ITC dominates the cream biscuits mkt with roughly 25% share & about 12% in the overall business market which is roughly 35,000 Cr in India.
Antiseptic / Hand Hygiene:
Dettol had over 85% share in 2015, which is when ITC acquired #Savlon from J&J. Again, fighting a giant with a near monopoly . Dettol was roughly 800 Cr brand in 2015, when Savlon was ~65 Cr. Fast forward 2020 -Salvon consumer spend exceed Rs 1000 crores
June 2020 : Tanishk_Ojha
Management Points on Tobacco
Several new variants were introduced during the year to cater to the continuously evolving consumer preference and ensure the future readiness of the Company’s product portfolio. Key market interventions during the year include the launch of innovative and differentiated offerings at the premium end such as Gold Flake Indie Mint & Gold Flake Luxury and the extension of Gold Flake Neo & Classic Rich & Smooth to other markets. The Business also deployed focused offers under the ‘American Club’, ‘Wave’, ‘Player’s Gold Leaf’, ‘Pall Mall’, ‘Navy Cut’, and ‘Flake’ trademarks in strategic markets towards bolstering and strengthening its market standing.
It is pertinent to note that since 2016-17 i.e. pre-GST, taxes on cigarettes have increased by 40%, i.e. at a compound annual growth rate (CAGR) of about 12% (on a comparable basis) - over thrice the rate of inflation during the same period.
Discriminatory taxation on cigarettes, has caused progressive migration from consumption of duty- paid cigarettes to other lightly taxed/tax-evaded forms of tobacco products, comprising illegal cigarettes and bidi, chewing tobacco, Gurkha, Zarda, snuff, etc. Consequently, while the share of legal cigarettes in total tobacco consumption in the country has declined considerably from 21% in 1981- 82 to a mere 9% (against global average of 90%), aggregate tobacco consumption has increased over the same period.
Illicit cigarette trade in the country has been growing at an alarming rate. Euromonitor International ranks India as the 4th largest illicit cigarette market globally.
While legal cigarette industry volumes have declined by about 20% between 2010/11 and 2019/ 20, the illicit duty-evaded cigarette segment has grown by 36% during the same period , accounting for about one-fourth of the domestic industry and making India one of the fastest growing illicit cigarette markets in the world.
The regulatory framework for cigarettes in the country is one of the strictest in the world.
The large and rapidly growing illicit cigarette trade also has a deleterious impact on the millions of farmers and farm workers engaged in the tobacco value chain. Since smuggled international brands of cigarettes do not use Indian tobaccos, in addition to revenue losses, the growth of the illegal cigarette trade has also resulted in a severe drop in demand for Indian FCV tobaccos in the domestic market.
It is pertinent to note that several other major tobacco producing countries, including the USA have framed regulatory frameworks for tobacco taking into consideration the economic interests of their tobacco farmers. The inadvertent and unforeseen consequence of the stringent Indian tobacco regulations and discriminatory taxation continues to adversely impact the livelihood of Indian tobacco farmers with corresponding gains to tobacco farmers in the countries that have opted for moderate and equitable tobacco regulations.
It is estimated that since 2013-14, Indian tobacco farmers have suffered a cumulative drop in earnings of appx. Rs.5,175 crore
Stability in taxes on cigarettes will have the salutary effect of enabling the legal cigarette industry to claw back volumes thereby engendering domestic demand for Indian tobaccos. This will also help cushion the impact of volatility in international markets.
May 2020 : Kartik Jajal
ITC acquire 100% stack in Sunrise Food
ITC has acquired a 100% stake in Kolkata based Sunrise Food Pvt Ltd. The company is in the business of basic & blended spices and mustard oil with the brand name ‘Sunrise’. Sunrise brand has a ~| 1000 crore sales in FY20 while the deal size is ~| 1800-2000 crore. The company is largely present in eastern India and operates through four factories in Agra, Bikaner, Jaipur and Kolkata. ITC is also present in spices business under Aashirvaad brand and is a leader in Telangana, Andhra Pradesh markets. The acquisition will help increase penetration of the Sunrise brand across the country while leveraging ITC’s wide distribution network.
March 2020 : Ashwini Damani
Tobacco Market Dynamics & Lopsided Taxation
1. Legally sold cigarettes in India are just 9%.
2. Beedi still has 81% market share
3. 9% market share belongs to smuggled cigarettes
4. Beedi is taxed very low compared to cigarette and costs also very low. Its less than 25% of a cigarette’s cost
5. Indian Tobacco has highest tax
ITC is present and competitively price in all Cigarette segments.
A typical person spends 50-150 a day on Cigarettes depending on his income/tastes
United Nations and Indian Govt both are working hard in tobacco curtailment
March 2020 : Bhaskar Jain
Few points which I think we can add to your note for completion:
BAT has voted against the ESOP policy (they don’t want their stake getting diluted) so going forward there will be no ESOP. Also ITC may not want to increase BATs stake, so no buyback in the future should be expected.
SUUTI stake sale overhang - around 8% holding they have of ITC