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ITC – Visit Note - Views on News from Equitymaster
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ITC – Visit Note
Aug 10, 2005

We met with the company last week to understand the company’s growth plans for the next three years viz. 2005 to 2008. Our focus was more on the paperboards and other FMCG businesses of the company. Here are the key takeaways. The need to diversify…
The rationale to enter to non-cigarette business to de-risk revenues and move away from being a single product company. As far as the contribution from cigarette and non-cigarette business is concerned, the company does not have an internal target, as each division is managed individually and run on its own. This is line with most of the international majors like Altria Limited in the US (Philip Morris). In our view, with cigarette companies increasing coming under government scrutiny, it is pertinent to have a diversified revenues mix.

However, any business that the company has ventured or may venture into is governed by three rules:

Rule 1: It has to earn its right to be a part of ITC's business.
Rule 2: The division should earn 18% as PBIT (profit before interest and tax) upon capital employed
Rule 3: Overall RoCE (return on capital employed) is targeted at 30% and above.

Cigarettes - Key highlights:

  1. Cigarettes account for 15% of total sales in India, of which the company's market share is at 70%.

  2. The company expects little support from the government, in terms of taxes on cigarettes (almost 50% of ITC's gross sales is accounted by excise duty). But sighted at the fact that even when compared to economies like Bangladesh and Pakistan, India ranks poorly on cigarette per capita and its share of the overall pie (50% in Pakistan). Cigarette consumption is a factor of taxes and income. Even if one assumes that taxes will continue to remain high in India, the company believes that as income grows, the gap between taxes and affordability will reduce. This, in turn, will result in higher cigarette sales. However, the shift is likely to be slower like in the past.

  3. The company spends Rs 1.5 bn to Rs 2 bn as capex towards the cigarettes division to improve quality and new products. Expects to sustain the capex in the future as well.

Hotels - Key highlights:

  1. As per the company, the hotel division's EBDITA margins were higher than that of Indian Hotels and EIH in the first quarter of 2006. However, the PBIT of the hotel segment in 1QFY06 at Rs 5.2 bn has to be adjusted for a one-time revenue of Rs 2.6 bn towards a sale of property.

  2. Total number of rooms under ITC Hotels is estimated at 5,200, of which 3,200 is owned. The company intends to open new hotels in Bangalore, Chennai and Hyderabad with the Bangalore expansion expected in 2.5 years while Chennai and Hyderabad will take even longer. The total capacity addition will be 750 rooms in the next three to four years.

  3. The company opined that it has the cash to invest in capacities and acquire hotels anywhere in India. But the problem it is facing, when asked, is there is tightness for project managers to execute expansions.

  4. Growth outlook is robust for the next three years.

Paperboards - Key highlights:

Manufacturing facilities:

  1. Kolkata unit - Manufactures specialty papers.

  2. Bhadrachalam unit - Total capacity of 275,000 TPA, of which 240,000 TPA is paperboards and the rest being specialty papers.

  3. Bollarum, Hyderabad - Processing of paperboards.

  4. Kovai plant - Acquired from BILT in FY04. Bought with the target that it will manufacture 65,000 TPA. It has crossed all benchmarks and is running ahead of capacity.

Value-add mix at 50%…
Specialty paper (used in cigarettes (the white paper), sun mica and steel rods) and Coated paper. The current mix between value-add and others is 50:50. In FY06, the contribution of value-add will be lower owing to the commencement of additional 75,000 TPA at Badrachalam (not a value-add paperboard). The fully capacity will be absorbed in FY06 and to that extent, growth is likely to be robust.

One of the key raw materials i.e. hard wood is where the company hopes to reap advantage going forward. In the northeastern regions of AP, the company is working with landowners, government by cultivating wasteland for the production of hardwood. The first harvest is expected soon, which was based on proprietary technology. In three to four years, the company hopes to meet most of the requirements from the domestic market itself.

Topline growth will be higher in FY06 owing to the new capacity of 75,000 TPA being fully absorbed, though margins are likely to be lower on account the new capacity.

Going forward, ITC will build expertise in paper (BILT and Tamil Nadu Newsprint being the major players). Will integrate forward into stationary (already launched), which in itself is a big market.

Other business:

  1. No new major initiative planned apart from the current ones. The company hopes to focus on integrating forward and backward in the existing business to achieve scale. But it depends on the opportunities that the company sees over the long-term.

  2. Rural market:  Rural market success for not only ITC but for any player depends on making more products available through the same distribution so that the end cost is lower. This is where E-choupal will help ITC. Agarbatties and matches are focused on these markets, though the contribution to the overall revenues may be meaningless. The same is the case with other FMCG products like atta.

  3. FMCG:  Currently, in FMCG, the company has presence in attas and biscuits. Going forward, ITC hopes to have a larger presence in processed foods and diary products as well. However, the time lines for the same are not finalised.

  4. Ready-mades:  The company has two key brands i.e. Wills Lifestyle and John Players. Any ready-made brand is unlikely to cross Rs 1.1 bn to Rs 1.2 bn because new variants and style can be replicated easily by competition. As the ready-made gains in scale, ITC will look at integrating backwards into fabrics!

What is our view?
We may have to upgrade our ITC numbers post our meeting with the company. However, from a two to three year perspective and even beyond that, ITC should form a part of an investor's core portfolio.

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