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ITC Vs BAT: Like father unlike son! - Views on News from Equitymaster

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ITC Vs BAT: Like father unlike son!

Mar 20, 2006

Despite the incidence of health problems and rising prices of cigarettes, consumers still find these products entirely seductive. This makes us believe that there are real fortunes to be made, especially in our country where the per-capita consumption of cigarettes is a mere tenth of the world average. In this article, we compare BAT, the world’s second largest tobacco company with our very own ITC. Here are the key takeaways. About BAT
British American Tobacco (BAT) was spun off in the reorganization of B.A.T Industries. It the world's second largest tobacco firm (behind the Marlboro maker, Altria Group) with a market share of about 15%. The company sells nearly 855 bn cigarettes in more than 190 countries. BAT has shifted its focus to emerging markets like Korea, Vietnam, and Nigeria for growth and is planning to build a factory in China, the world's top tobacco market, consequently moving its Asian headquarters to Hong Kong.

BAT in a nutshell…
(Rs m) CY02 CY03 CY04 CAGR
Net revenues 1,827,821 1,889,066 2,468,918 16.2%
Expenditure 611,996 627,370 643,547 2.5%
EBITDA 1,215,825 1,261,697 1,825,372 22.5%
% margin 66.5% 66.8% 73.9%  
Profit after tax 101,416 61,714 95,012 -3.2%
% margin 5.5% 3.3% 3.8%  
EPS (Rs) 78.0 41.3 78.8  
P/E ratio (x)     14.4  
* Provisional results   1 Sterling Pound = Rs 78

About ITC
ITC commands about 70% of India’s Rs 130 bn domestic cigarette market (value terms). Out of the top 10 brands in India, 6 belong to ITC. The growing awareness on harmful effects of tobacco as well as the government’s punitive tax policy, forced ITC to move towards de-risking its revenue profile. Consequently, it merged the paperboards subsidiary with itself and invested in growing its hospitality, retailing, packaged foods and IT businesses. Consequently, the ITC group has emerged as the second largest luxury hotel chain after Indian Hotels. In packaged foods, its product range includes ready to eat (Kitchens of India), staples (Aashirvaad Atta and Salt), confectionery (Mint-O and Candyman) and biscuits. ITC has also entered into garment retailing and has 42 Wills Lifestyle stores. Other initiatives include greeting cards (20% market share), safety matches and incense sticks. BAT, the company’s parent holds a 32% stake in the company.

ITC in a nutshell
(Rs m) FY03 FY04 FY05 CAGR
Net revenues 60,350 66,950 78,750 14.2%
Expenditure 37,120 41,100 48,470 14.3%
EBITDA 23,230 25,850 30,280 14.2%
% margin 38.5% 38.6% 38.5%  
Profit after tax 13,710 15,390 18,370 15.8%
% margin 22.7% 23.0% 23.3%  
EPS (Rs) 55.4 64.3 90.0  
P/E ratio (x)     29.2  

ITC as a % of BAT
Revenues 3.2%
Expenditure 7.5%
Net profit 19.3%
As can be seen from the table alongside, BAT has grown at a faster pace than ITC. One of the reasons for the same could be attributed to the fact chewing tobacco has been a tradition in India for centuries. Of the total amount of tobacco produced in the country, around 48% is in the form of chewing tobacco, 38% as bidis and only 14% as cigarettes.

Major Brands
Pall Mall India Kings
Dunhill Goldflake
Kent Navycut
Lucky Strike Bristol
Vogue Wills
Thus, bidis, snuff and chewing tobacco form the bulk (86%) of India's total tobacco production. In the rest of the world, cigarettes accounts for around 90% of total production of tobacco-related products. This unique tobacco consumption pattern is a combination of tradition and more importantly, the tax imposed on cigarettes over the last 2 decades. In contrast, in the United Kingdom, cigarette accounted for around 75% of total consumption (rest contributed by cigars and pipe).

Just to put things in perspective, while around 73% of ITC’s revenues is from cigarettes, BAT has a concentrated revenues mix (tobacco-related product account for 100% of revenues). The net margins of ITC (23.3% in FY05) are much higher as compared to BAT (3.8% in CY04). It must be noted here that ITC’s hotel division margins are amongst the highest in the industry at 35%+ levels.

What to expect?
Despite high government intervention and campaigns against smoking, ITC has managed to grow its portfolio and going forward, we expect it to outperform its peers. As disposable incomes increase, people might shift from bidis to cigarettes and hence, upside from conversion exists. Also, demand for cigarettes is relatively inelastic, owing to its habitual nature.

Further, the company has emerged as the second largest player in the hospitality sector in India, behind Indian Hotels (The Taj Group). ITC has around 5,200 rooms, of which 3,200 are owned while the rest are managed properties. The company plans to open new hotels in Bangalore, Chennai and Hyderabad in the next 3 to 5 years. This division continues to benefit from capacity expansion as well as the upturn in the industry's occupancy rate. Margins are also likely to be robust going forward. With this expansion, the company's rooms under management will increase by 750. To conclude, we expect the cigarette business to remain the mainstay for ITC in the future. However, its other businesses, especially paperboards and hotels, are likely to contribute greater to the overall growth. We had recently assigned a ‘HOLD’ rating on the stock and we continue to remain positive on the company’s future prospects.

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