ITC has come to be a synonym for cigarettes in India, with 6 out of the top 10 brands coming from the company's stable. People usually associate ITC only with cigarettes, often forgetting that the company has other businesses as well. The company, however, did understand the risk of being in a regulated sector and expected the government intervention to increase over time. Considering this risk, the company forayed into the paper manufacturing business two decades ago, which was targeted at backward integration as well as de-risking its business model. In this article, we take a look at ITC's Paperboard division and leave cigarettes alone for a change(!).
Though the first six decades of the company's existence were primarily devoted to the growth and consolidation of the cigarettes and leaf tobacco businesses, the seventies witnessed the beginnings of a corporate transformation. The company's multi-business portfolio now encompasses a wide range of businesses like cigarettes & tobacco, hotels, information technology, packaging, paperboards & specialty papers, agri-exports, foods, lifestyle retailing and greetings & stationery. Though the company is diversified, the core business i.e. cigarettes continues to contribute almost 75% of revenues.
The non-tobacco shift!
The share of cigarettes out of the total tobacco offtake has declined from 21% two decades ago to 14% currently, despite the FMCG industry in India clocking a CAGR of 8% during this period. High government taxes on cigarettes (which amount in excess of 130% of the net value of the product) is a key cause of concern for ITC, If one looks at the broader numbers, it is both an opportunity and a threat (India's per capita consumption of cigarettes is 119 sticks per annum as against the world average of 1,267 sticks per annum).
Then, why did ITC diversify? The answer to this question lies in understanding what is happening in the global markets. MNC companies like Phillip Morris are under intense regulatory and public scrutiny with respect to the health impact of cigarette consumption (law suits are a common phenomenon). In such a highly 'regulated' sector, from ITC's standpoint, it is important not to put all eggs in one basket. Therefore, the case of diversification into hotels, paper boards and so on.
Paperboards & Speciality papers
With the acquisition of BILT's 65,000 tonnes paperboard capacity, as well as its own plans to increase capacity by 75,000 tonnes by FY06, we believe that ITC will benefit from economies of scale going forward (the behavior of pulp prices however remains to be seen).
ITC's paperboard unit at Bhadrachalam is the largest and most contemporary paperboards manufacturing facility in the country and accounts for over 80% of the company's total installed paperboard capacity of 325,000 tonnes. This segment of the company supports some of the biggest brands in India. We see them on every supermarket shelf and retail outlet, straddling all carton consuming segments including foods, beverages, pharma, personal care, durable goods, etc. ITC's clientele includes the likes of Nestle, HLL, Colgate, Dabur and Barista.
This division has grown at a CAGR of 15% during the period between FY02 and FY05, outperforming the company's cigarettes business' growth (7%) during the same period twice over. The future of this segment is promising and will see growth and profitability because of economic upturn and better product mix that will help margins improve. The company is also increasing its capacity to 400,000 tonnes by FY06. We expect this segment to grow at a CAGR of 6%-7% and value added paperboards to clock 15%-20% growth.
How the numbers stack up for this division?
As can be seen from the table below, the contribution of the paperboards division to total revenues stood at 11.7% in FY05, up from 9.8% in the previous fiscal. Also, ITC Bhadrachalam is one of the most energy efficient paperboards producers in the globe and more than 95% of the energy consumed by the unit is generated internally. It is also the largest exporter of coated paper in India, with nearly 20% of its production being exported to 40 countries.
Paperboard business: Past performance
PBIT margin %
% of total Sales
The range of paperboards includes cast and coated paper used in the pharma industry, virgin boards used by FMCG companies, greeting cards and premium cosmetics and Cupstock used for soaps, ice creams and beverages.
Thus, to conclude, while we expect the cigarette business to remain the mainstay of ITC's backbone in the future, its other businesses, especially paperboards and hotels, are likely to contribute greater to the overall growth. At the current price of Rs 1,745, the stock is trading at a price to earnings multiple of 19.8 times its FY05 earnings, which we believe is at the higher end of the spectrum from a medium term perspective.
ITC Ltd has announced third quarter results of the financial year 2016-2017 (3QFY17). The company has reported 4.7% YoY and 5.7% YoY growth in revenues and net profits respectively. Here is our analysis of the results.
LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.
SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.
Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India. Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: firstname.lastname@example.org. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407