Is a ‘BINGO’ moment on the cards with demerger of ITC?

Our take on what's leading to rise in ITC stock price...

ITC stock closed yesterday with gains of over 6%. This is the second time this week when this stock has gained more than 5% in a day. This may be common for any other stock in the Indian Markets, but when it comes to ITC… It was an Aahhhaaaa moment!
Why? Because it is one of those heavyweights which has remained almost stagnant since last 10 years and has given average annual returns of only about 8%. Way too less when compared with other Blue-Chip stocks.  So, what has happened suddenly that this stock has rallied by more than 11% in last week? Let’s try to decipher that today with one reason being obvious and the other being a speculation and this speculation we are more interested to analyze.

First the obvious reason: No increase in taxes over sale of Cigarettes. This was a big relief moment for ITC because almost half of its revenue comes from the sales of cigarettes. Something which has been happening year after year was almost definite to happen this time too because of Government wanting more money. Hence, no increase in cigarette cess was a moment of celebration for ITC fans. So, after a tepid January we got to see a fantabulous February with respect to ITC prices.

Now the second reason is interesting although a mere speculation, but yeah it is totally rife. On 11th February’21, ITC is going to announce its Q3 financial results and with that its going to announce the demerger of its hotels and other FMCG business from its core tobacco business. That’s some big news for sure. Although a mere speculation, we couldn’t resist to analyse further if there’s a separate stock of non-cigarette ITC businesses, would it really be a value buy?

Let’s take an example to peruse this further: ITC’s revenue from cigarettes has been continuously falling year on year, but its margins or as we commonly say the contribution to the profits has been increasing continuously year on year. In the last year itself, the contribution of revenue from cigarette business was 46.46%, but 66.89% earnings came from this business itself. And when compared with the FMCG arm, even though its revenue contribution was 22.60% but its contribution to earnings was hardly 3.69%.

One may put a counter statement that in coming years, the revenue of other FMCG goods will surpass the revenue from cigarettes, but how much would it contribute to the bottom line? Let’s take another example to understand this with a comparison of profits for the years 2017-18 and 2018-19. In these years the contribution from cigarettes in case of revenue decreased by almost 6%, which means the contribution to revenue increased by 6% for non-cigarette business. But how much did it contribute to the profits? JUST 1%. Even if we take this as the initial brand building phase, still profits from regular FMCG goods don’t go above 2% or 3%. Imagine how much time it would take for reaching the profit levels of cigarette business at this rate?

Nevertheless, the above thoughts are derived from rationality. But if try to see from the lens of reasonability, ITC has always been a prominent example of entering into market spaces dominated by monopolistic or oligopolistic players and disrupting it perfectly. Whether its Aashirvaad atta dethroning Pillsbury and Annapurna or it is Bingo, giving tough competition to PepsiCo, the list is endless with each product launch of ITC strengthening its position in this space. So one can never be sure what magic this disruptor can do to the earnings and subsequently to the stock prices.

Till then let’s wait till 11th Feb to see if this speculation turns into a reality. But for sure you’ll not have to speculate in terms of receiving our next article if you subscribe us right here:

By: Anmol Gupta | Isha Garg