ITC is Up 33% in 2023. Does This Value Stock Have Room to Rise?

ITC is the Indian stock market's favourite value stock. No matter how much the rises, investors believe it could go up further.

And they're not wrong. The stock is being driven by a combination of rock solid fundamentals, good growth, and the value unlocking from the demerger of the hotel business. The hotels business is also getting a boost due to the Cricket World Cup 2023.

The stock is up about 33% this year but the market believes that it has the legs to rise some more. In fact, many value investors are convinced the stock is a great long term investment.

They could be correct in their assessment of the stock. The company is run by a good management team. It's core businesses are all doing well. It's generating huge cash flows. This has made it one of the best largecap dividend yield stocks in India.

All this means that investors have seemingly made up their minds that ITC is 'not a sell'. They're either buying the stock on dips or just holding on.

This lack of selling pressure, aside from the regular profit booking from some traders, is the reason why the stock has shown remarkable stability.

Here's the stock price over the last three years...

During the stock market's boom phase in 2022-21, ITC was solid but did not go up a lot. It was a big underperformer. This made it India's meme stock at that time. But how times have changed!

The meme phase for the stock ended with its underperformance in 2022. Since then the stock more than doubled at a time when the benchmark indices haven't delivered stellar returns.

And despite the recent correction, it looks like the stock is poised to go up more.

Here's what Rahul Shah, Equitymaster's co-head of research, had to say...

• At a PE multiple of 28x, the stock is only marginally lower than its long-term average of 29-30x. This means that the stock is fairly valued from a trailing twelve-month earnings perspective.
  
  On the earnings front, the results for the June 23 quarter haven't been very encouraging. Although the bottomline for the quarter has gone up 16% YoY, the topline was down 7% YoY as the agri-business suffered on account of export restrictions put in place by the government.
  
  On the positive side, the company is finally demerging its hotels division into a separate entity.
  
  Exiting or demerging the hotels business was a longstanding demand from ITC shareholders. It was gobbling up a lot of capital on account of its capital-intensive nature.
  
  Now that the demerger has finally happened, the company will have more cash to spare which can be used to either pay more dividends or invest in something more productive.
  
  As far as earnings growth is concerned, I believe that the company is quite capable of achieving a growth of 15% per annum in earnings over the medium term.
  
  And this combined with the dividend yield of around 3%, adds up to the stock price going up 17-18% CAGR from a 2-3 year perspective.
  
  Plus, there are other positive levers like the listing of the hotels business, improved profitability and cash flows of ITC and thus, better dividends.

You can read the full article here.

This is why the stock remains a favourite of investors and a widely held stock. The recent correction from the all-time high of around Rs 500 has not deterred value investors.

In fact, value investors would probably like it if the stock fell a little more in the short term. This would allow them to buy more shares at a reasonable valuation.

The stock's current PE ratio of 27.5 does not make it very expensive but it certainly puts it out of the comfort zone of many die hard value investors. This is probably why the recent correction hasn't ended as of this writing. Value investors are just waiting for a better price.

But it doesn't seem that they are selling the stock. The recent selling can be explained by two factors.

First, the recent quarterly results wasn't great. The agri business suffered because of the restrictions imposed by the government.

And second, investors were not happy with the demerger ratio announced by the company.

After the demerger of ITC's hotels business, ITC will continue to hold a 40% stake in ITC Hotels and the balance will be held by the company's shareholders proportionate to their shareholding in ITC.

This came as a surprise to retail investors as they won't get 1 share of the demerged entity on the same proportionate basis as their holding in ITC. Many were expecting a straightforward 1:1 ratio.

The stock is thus going through a churn. Investors who were disappointed by these two announcements are selling. Short term traders who were long on the stock are also selling as their stop losses get triggered.

But otherwise, there isn't any kind of serious selling pressure on the stock. Long term investors holding the stock are not concerned about this minor correction.

However, the recent underperformance of the stock, relative to the Nifty, will probably keep most of the non value investing crowd away. After all, if the entire market is going up, then why buy ITC which is in a downtrend?

This thinking could lead to a kind of self-fulfilling prophecy in the short term. The stock falls because there are more sellers than buyers and there continues to be more sellers than buyers because the stock is falling.

The good news is that such situations are temporary for fundamentally strong stocks. Eventually the stock's PE ratio falls to a level where value investors become interested again. In fact shrewd traders with deep pockets also buy such falling stocks in anticipation of value investors getting in.

When this happens, the stock will stop falling and reverse its direction.

Conclusion

After looking at all sides of the debate on the stock of ITC, we conclude with the following points.

If you're already an investor in the stock of ITC, you have nothing to worry about in the long term.

If you're a trader, then you should study the charts for signs of a reversal.

If you're a value investor who hasn't bought the stock yet or wants to buy more, you could get an opportunity if the correction continues. The long-term average PE for the stock is around 30 and it's trading only a little below that level as of this writing.

Keep this stock on your watchlist and track the developments surrounding it closely.

Happy Investing!

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...