Safe Haven.





     First of all, before starting out, I would like to categorically state that this article has little to do with the eponymous romantic novel by Nicholas Sparks or the resultant film. The above image is merely a red herring. This blog, after all, still revolves around the corporate world and it doesn’t cater to the domain of romance. Not yet anyway. The scene over at Dalal Street, however, is anything but romantic. The fatal emotions of fear and panic have gripped the Indian bourses and with the Indian Rupee crashing through all its support levels, the markets have taken a nosedive. Moreover, a sub 4.5% GDP growth rate, a ballooning current account deficit and structural downgrades by global rating agencies such as Fitch and Moody’s have only exacerbated the situation. With foreign institutional investors (FIIs) pulling out funds from India, virtually every stock out there is in descent mode. In such a scenario, defensive sectors such as FMCG (fast moving consumer goods), pharma and IT, which tend to fall less sharply than the broader markets, are back in favour. The FMCG sector just so happens to be the most alluring space today and one particular company in that very sector might just prove to be the safest haven amongst them all.

     With a market capitalization of over Rs. 2.5 lakh crores and with the distinction of being the bellwether of the FMCG sector, ITC is indeed a market heavyweight. With a topline in the region of Rs. 33,000 crores and a bottomline of Rs. 7700 crores, ITC boasts some of the best margins in the industry. A strong cash flow position, a virtually debt-free balance sheet and an unblemished dividend payout record all combine to make ITC the market favourite that it is today. After all, with a market share of over 80% in the cigarette space, ITC is by far the best example of a consumer monopoly in India today and no MNC can swagger in and steal that lead. Altria made a brave attempt to do just that with its Marlboro brand but ITC, with legendary brands of its own like Wills and Kings, stood its ground and entrenched itself deeper into the Indian market. Its distribution muscle is unquestionable and the tobacco arm of the company is undoubtedly the cash cow of the company.
     However, in the recent past, growth in cigarette volumes for the company has slowed down to just 2% on an annual basis. Nevertheless, the company has managed to counter that by introducing variants at the premium end of the market and sub 6 cm cigarettes, which attract a lower duty. It is a well known fact that ITC happens to be the favourite whipping boy of the government since the latter always resorts to duty hikes on cigarettes, in order to meet its budget shortfalls. ITC has always responded by increasing prices but that strategy did return to haunt the company on the cigarette volume front. However, that 2% volume growth appears to be the bottom for now and the company has started seeing a healthy uptick in recent quarters. With today’s turbulent market and gloomy economic scenario, the tobacco arm will be the one business that will continue to propel ITC. After all, economies may crumble all over Europe, America and Asia but that certainly will not impact cigarette consumption in India.

     While the tobacco business may constitute ITC’s core, the company has other arms that are clocking faster growth rates and at the same time, promoting the cigarette brands. The FMCG business, which ITC ventured into over a decade ago, is notching up a healthy 20% annual growth rate. In the soaps, shampoos and personal grooming space, ITC is battling Hindustan Unilever (HUL) and Procter&Gamble (P&G) and has managed to capture a slice of the growing market. Its brands such as Fiama Di Wills, Essenza Di Wills, Vivel and Superia have stolen market share from biggies such as Dove, Ponds and Pantene. The company is making inroads into new segments such as the deodorant market, which is dominated by Axe and Fogg. Engage, ITC’s new deodorant brand, is riding on its wide distribution network and its competitive pricing. ITC has also drawn up plans to foray into the oral care segment and take on the likes of Colgate, HUL and GlaxoSmithKline. On the opposite end of the FMCG spectrum, ITC’s packaged food brands such as Kitchens of India, Candyman, Sunfeast and Bingo! are already household names. In the closing quarter of fiscal 2013, ITC’s FMCG business turned profitable for the very first time and from here on, its contribution to the bottomline will only increase. In what can easily be described as a bold, brash and audacious move, ITC also publicly declared its intent to become India’s largest FMCG company in a few years from now.
     The FMCG giant is also present in other segments such as paper, packaging and agri-business, all of which are lucrative businesses and it has also entered new lines of business such as IT and apparel. The apparel part of the business, namely Will Lifestyle, is merely designed to promote the company’s cigarette brand in a surrogate manner. ITC is contemplating an entry into the dairy business, by riding on its existing agri-business networks and infrastructure. However, if there’s one division of the company that sticks out like a sore thumb, then that would be the hotels division. Despite the fact that the contribution to the overall topline is miniscule, ITC Hotels is a drag on the parent company’s balance sheet and its financials. Furthermore, the ruling economic scenario is certainly not helping its cause. In fact, ITC Hotels, which was once a standalone company, was merged into the joint entity over a decade ago just to bury the hotels’ losses under the profits from the tobacco business. Noticeably, the tobacco business executes the unenviable task of incubating ITC’s new lines of business but if those businesses do go on to mirror the success of ITC’s FMCG business, the effort may be well worth it.     
     On the valuation front, ITC normally trades at a price multiple of over 30 times and in FY13, the company declared an earnings per share (EPS) just shy of Rs. 10. While a 30 time price multiple may be a tad expensive, ITC trades at a significant discount to peers such as HUL and Nestle, which quote at a 37-45 time price multiple. The dramatic rise in ITC’s stock price in recent months was partly due to the euphoria surrounding Unilever’s open offer for an additional 24% stake in HUL. After the conclusion of the open offer, in which Unilever only managed to gather a 15% additional stake, both HUL and ITC began their descent. One of the reasons HUL trades at a 40 time multiple is due to the fact that its parent company Unilever holds a 66% stake in it. When it comes to foreign shareholding however, ITC is certainly no laggard. Besides an FII holding of 20%, British American Tobacco (BAT) holds a 31% stake in the company and it seems to be locked in for the long haul.

     In the first quarter of fiscal 2014, ITC reported a topline growth of 10% and a bottomline growth of over 18%. The markets, in their typical fashion, chose to ignore the fact that the company’s margins were improving and punished the stock for a topline growth that was below Street estimates. Along with the general pessimism prevailing on the bourses, ITC crashed around 20% and it now quotes at a forward multiple of a little over 25 times. With the company all set to register an EPS of at least Rs. 12 in the ongoing fiscal, its valuations are indeed attractive. The stock markets, after all, have the habit of panicking and over-reacting. While its recent correction may be little more than an aberration, ITC has the reputation of falling less sharply than the market and rising at a much faster pace than the overall market, awarding it the distinction of being an outperformer. Considering its strong financial performance and its dominant market position, a target of Rs. 400 on the bourses may be hit in the next 9-12 months.
     While carnage may be the order of the day on the Indian bourses, the FMCG sector continues to hold its head above water. Today, traders and investors still sail the stormy seas of the Sensex, hoping to ride out the storm in one piece. And in those choppy waters, safe havens are few and far between. ITC, however, may just turn out to be the best port in the storm.          

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