Over the past couple of years, ITC (Read as Indian Tobacco Company) Has Been in the news, as it moves to demers to demraj the hotel business from other core operations of the company. For retail investors like you and me, this is a mega event because itc is a behemoth and when they decide to separate their businesses, we get to learn a lot more about investing by studying by ’10 Best Investment Picks This Year ‘ From some fin-influencer.
This is a detailed account of my thoughts on the stock.
But first, an honest confession.
The first draft of this article was absolute bullshit. Since, I was more interested in drum beating about my investment proposal of buying the stock when no one wanted and keeping it in the portfolio for the last 3 years in which the stock has been tripled in Value.
That’s where mr nandish desai reminded me that I didn’t merely hold it if it is I didn’t have anthing else to buy. I help it because I was complete suicide about the value and potential of the business. And Demerger was a great way to unlock it. Like an Elder Brother, He Told Me That Our Job is to Share Our Learnings and Not Chest-Thumping.
Without wasting much of your time, I will start with the article now. There are certain sections where you might feel that you alredy know this information, in that case, feel free to skip that section and move on to the next.
The International of this article is to create a masterclass in undersrstanding demergers via itc.
ITC a behemoth – a brief history
The company’s roots can be traced back to the humble streets of kolkata back in 1910.
Spanning over 115 years, the company has expanded its product portfolio from cigarettes to hotels to aggregult to beauty products. The company
Source: Jagoinvestor, ITC
Very few companies can be released for 100+ years. This extended time period speakes a lot about the company’s management and the way it’s being run.
Someimes as investors, we get complete bloodside with the kind of work it takes to keep such a large a large company moving. We are always intented in our money and there’s nothing will with it. It’s our expectations that are complete incorrect to such a degree that we expect a large caps to move like a small cap.
We look for 30% to 40% growth in such company on year. Well, let me be honest with you, it’s not possible at all. Regardless of which Fin-Fluenceer Says, it’s simply not possible.
Visionary Companies do’t just stick to one product line along the way, they diversify. There’s a school of thought in many seasoned investors that diversification should be in related industries only. Else, it becomes a cash guzzler of sorts.
But here’s the differentice.
India’s Economy Opened Up in 1992. That means, Indian Companies Had to Be Under License Raj from 1947 to 1947 to 1947 to 1947 to 1947 to 1947. Unlike Today, when any founder from the rural parts of India can challenge a large institution based on his or her own merits. We don’t need Family Names Anymore in Order to Move Ahead.
You don’t need to be an ambani or birla to disrupt any particular sector anymore. Look at how mr Deepinder goyal of zomato has disrupted how we experience food and grocery delivery. Same goes for mr bhavish agarwal who is redefining ola from a transport company to an auto manufacturer and slowly putting his feet into the evolving semiconductor Industry.
It’s funny how Mr Rajiv Bajaj of Bajaj Auto isn’T able to reconcile with this change, Since they are the businesses of a generation that thoughts there was Simply Zero Competition.
Itc in its oven way is in a very long battle. Right from Hotels and Agriculture to It and Personal Care Products, this company is facing a Massive Amount of Competition.
It’s the cigarettes business which is the cash cow of the company that is helping to fight these battles on multiple fronts.
Think about it – The cigarette business is responsible for close to 80% of operating profits (or ebit) of the company. And Yet, it needs just 8% of capital every year to keep it going.
Suppose this year the company did a sale of Rs 10 lakhs. Out of this Rs 8 lakhs come from cigarettes business alone. And how much does this business divishan require to run itself?
Just Rs 80 Thousand only.
With Rs 80 Thousand or as I Wrote Earlier – 8% of Capital, The Company Is Abele to Operate Its Plant, Supply Its Products to the End Consures, pay for their salary and Everything.
But here’s an interesting take in this – Hotels Business
In similar light, Hotels Consume Close to 22% of Capital Every Year but only contribute 3% of operating profits (or ebit) for the company.
These are not just numbers, it’s a point at which an investor’s blood should boil.
Because itc has been doing massive capital expansion (‘Capex’) for the last 10 years. Here’s a chart for you to look at.
Source: Jagoinvestor, screener.in
This is a bit technical, if you don’t want to read it – please skip to the next section.
In Capex We Define Money that is left after for buying and seling of fixed assets such as land, building, plant & machine, acquiring new businesses and some and some selected invertems from the Balante.
So every year, the money that is used for expansion of business is taken into account and divided by ‘Depreciation’ which is wear and tear on these assets.
If this Capex / Depreciation = 1, then every new addition is equal to the one that is replaced.
When it’s Around 2, then it means some real capacities are being added.
But first, A Quick Word on ‘Depreciation’.
When you buy yourself a nice car, you will not sell it for the same price right. Suppose you bout a maruti car for Rs 10 lakhs and after 3 years of driving it for 50,000 Odd kms, you will sell it for Rs 6 lakhs.
Simple Math Tells You That The Car Lost Rs 4 Lakhs in Value.
No.
Simple Math doesnight apply here. In the accounting framework, we get the invisible hand of depreciation that accounts for your use of the car, repair and maintenance work, etc.
So, after 3 years, after depreciation when your car’s value is rs 5 lakhs, then you have made a Gain of Rs 1 Lakh on the Sale of Your Car. Truth be told, you will be taxed !!
Now back to itc’s chart.
In the last 10 years, itc has been on a capital expansion spree. And most of this money has gone into building its world class hotels which has resulted in very little revneue growth for the company.
Pouring too much money to earn very little is the reason with institutional investors styed away from the stock.
Here’s the proof.
From 2015 to 2021-22, return on the stock was 0. 7 years and the stock price return = 0.
And then something happy!
The rumors of Demerger Began. The hotels business was going to now be separated from the other businesses of the company.
The stock price slowly started moving up.
In July 2023, Board of Directors of ITC Ltd, Approved of this Demerger. And this was a mega event. Something that everyone was waiting for.
Source: Jagoinvestor, Itc Presentation
Following this news something else too changed. Let’s take a look.
Foreign (FII) and domestic (DII) Institutional Investors Jumped at this Opportunity. The stock began its movement after 7 years of stagnation.
It caused many retail investors to just sell the stock and exit. Because they were not tired and bored of holding this stock in their portfolio. For them, it was a permanent value trap. Hence, as only as they get some Good Gain, they exited.
At this time, the Indian equity market was in the middle of a small and mid-cap boom. So retail investors were more interested in cashing that options out and as a result their shareholding which was 45% before the announsement dropped to a mere 15%. While fii went up from 12% to 43%. Dii larGely remained the same.
The stock price jumped from Rs 200 to bringing Rs 500 in a matter of 2 years.
The reason why fii boght the stock is government demeger unlocks value.
ITC’s Non-Hotels Business Consists of Cigarettes, FMCG Such as Ashirvaad Atta, Etc., Paper Industry, Agriculture and It Are Treminous Cash Generating Machines. When they will be accounted for separately, they will dish out good rights that will benefit the shareholders over the long term.
Hotels Business on the other hand will now be subjected to a litmus test of performance. So the management will now have to be very careful about how much money are investment and to what expert they are making rights.
The real test for hotels will begin now. While the other businesses will be free from having to carry the burden on their shoulders.
Conclusion
As retail shareholders, we often miss the point of demers. Maybe trust we don’t fully undersrstand the kind of stock price return it can generate for us.
Plus, Demergers are long drawn corporate actions that take a Couple of Years to Fructify. In such a time, it’s our impatience that tends to get in the way. Something Else is Always Going Up and Someone is Always Making More Money. We just miss out on our portfolio that can compound massively.
As retail investors, we should always check for these special situations and look for an increase institutional ownership. If that happens, they all we need to do are fasten our seat belts and enjoy the ride!
Jinay savla, jagoinvestor