Going at full tilt
Admirably enough, the shareholders of ITC Ltd. have prospered under Yogi Deveshwar's stewardship as the great helmsman of the company for the last 14 years. In 1996 the company had clocked a gross turnover of Rs 52 bn, an after tax profit of Rs 2.6 bn and a market capitalization of Rs 55.7 bn. In FY10, it had ratcheted up figures of Rs 260 bn, Rs 40 bn, and a market capitalization in excess of Rs 1 trillion. That is no mean achievement. And the company is ringing in its centenary year in style - a record percentage dividend payment, and a record dividend payout, and a 1:1 bonus to boot. The dividend outflow will however more than eat away every dime that it earned as book profits during the year and then some more. Coming to think of it, ITC must be the only publicly listed MNC (in a manner of speaking) of such vintage, which is getting more and more vibrant by the year.
Tobacco is its savior
But then, the company had one plus factor going in its favor all through these years, and the plus factor product had only to be nurtured. ITC was, and is the market leader in a very niche product line - tobacco, whose growth is assured, irrespective of the many roadblocks that are progressively erected in its growth path. The government induced legal restrictions, including a ban on advertising on the one hand, and, the ever escalating central and state ‘sin' taxes levied on the industry to garner more revenue on the other. When the company's name got metamorphosed repeatedly, over time, it was for a double edged reason. To get rid of the imperial tag initially, and, to get the message across that it is a diversified business. But sadly, the latter has not happened.
The company is indeed lucky that it retails in one of the four major weak spots that confront humans - smoking, drinking, gambling, and fornication. None of these addictions can unfortunately be eradicated, or even cubed through executive fiats. As a matter of fact the more severe the level of governmental dirty tricks on the industry, the more firmly entrenched ITC becomes. Its market share rises at the cost of other established local rivals. In any event the company has very little local competition today, with the competition having stubbed itself out. Along with VST Industries, the Hyderabad based surrogate that it controls, it has a virtual stranglehold on all conventional forms of retail tobacco, barring beedis that is. Wonder why the management never thought of diversifying into the hard core liquor (IMFL) business. After all liquor, cigarettes and the hotel industry together, complement one another, right? Unlike the several other FMCG businesses that it got enmeshed into, and which are almost asphyxiating it today, the company could have hit pay dirt in liquor on day one itself.
Needs to tone up its HR practices
The management wastes no opportunity in prattling about ITC being one of India's most admired and valuable corporations, its search for excellence, and its never ending journey to create enduring value. But it appears the company does not even have a retirement policy in place for its senior managerial staff and the non executive board members. Its non executive directors comprise of a bunch of geriatrics with the oldest among them being a very young, 75 years, with the next in line being 71, and an average age of about 65. And amazingly enough, for a company its size, It makes do with less than a handful of executive directors and the senior most one, age wise, has just retired at a youngish age of 65. That will give Mr. Deveshwar another 2 years in the corner office, assuming that 65 is the retirement age for the top management. For the moment he is happy accumulating stock options, and a large shareholding too, which should help him lead a very comfortable existence post retirement.
In spite of the company's diatribe against the rigorous and ex-cathedra imposition of indirect taxes, and the consequent flooding of the markets with imported cheapsters, its overall emphasis is still on this bread and butter business. Tobacco sales (including unmanufactured tobacco), accounted for 71% of all gross sales, against 69% in the preceding year. The tobacco business (excluding unmanufactured tobacco) also accounted for 84% of the segment profits against an even higher 89% in the preceding year. To make a long story short, in spite of repeated statements to the contrary by the management, the company continues to be something of a zero, minus the tobacco business. Next in the pecking order, is the packaged foods biz with 9% of overall sales and the paperboard biz with 7% of overall sales. The entire other FMCG business, which includes garments, stationery, personal care, matches, agarbattis etc, still continues to drill a hole in the pocket wallet. Some of the agri products that it buys and sells, is merely there to complement total sales. For example it bought Rs 2.5 bn worth of soya seeds and sold the same quantum for Rs 2.4 bn, incurring a marginal loss in the process.
ITC sold 84 bn cigarettes or 5.6 bn more cigarettes in FY10 than in the preceding year. The catch is that it produced only 69 bn cigarettes, which is slightly lower than what it produced in the preceding year. The balance sales came partly from stock in hand, but it still had to outsource some 11 bn cigarettes, or 13% of all the cigarettes sold. During the same period the installed capacity for cigarette manufacture grew to 134 bn from 110 bn, thanks due to the new factory that it set up at Pune in Maharashtra, and other balancing equipment that it may have added to its existing plants. That would also imply a slight mismatch in the planning process and with the authorities going for the jugular, one wonders why the company keeps adding to its manufacturing capacity. The moot point is how the company has accounted for these outsourced cigarettes. There is no mention of any purchase of cigarettes in the schedule of ‘Purchase of Finished Goods for Resale'
No 1 in FMCG?
Gross sales wise, the company is the numeo uno in the FMCG business, but it is mainly due to a quirk in the taxation structure. If one excludes the indirect tax levies of Rs 81.1 bn, which accounts for 31% of gross sales, then it does not quite measure up as top dog. But one may also add here that the company has also achieved this gross sales distinction by spending a mere Rs 5.2 bn on advertising and sales promotion in FY10, across all product lines. It makes one wonder about the efficacy of advertising in the first place.
Dabbling in debt instruments
Like all corporations it has it has developed a passion to buy and sell liquid debt investments, for reasons which are not very clear. The company, as a matter of fact, bought and sold cumulatively a phenomenal Rs 1.1 trillion worth of such investments during the financial year, but the other income schedule does not show any returns commensurate with this effort.
Replete with subsidiaries
As a matter of fact the company is replete with subsidiaries and associates, some of which are not worth more than an embarrassed laugh. Bay Island Resorts, and Srinivasa Resorts which run motely hotels for one. Even its IT subsidiary, ITC Infotech India Ltd is not getting anywhere. Russell Credit, has a paid up equity of Rs 6.5 bn, but could log a turnover of only Rs 518 m, with an after tax profit of Rs 420 m. All of ITC's ‘faltering' investments, at one time were locked into Russell Credit. The smart investments however, have just been shifted out to the parent's portfolio.
For the matter of record ITC has 25 subsidiaries including 3 in Australia, 3 in the US, 1 in the UK 1 in China, and 1 in Nepal. Then there are 2 JVs in which it has a 50% stake, and a further 7 associates in which it has varying levels of equity holding. Collectively, the dividends that it got from these investments were a princely Rs 145 m. It is now de-rigueur for large Indian companies to sport a motely bunch of half baked subsidiaries.
The company's bellwether tobacco business will continue to be its mainstay biz in the foreseeable future. There is simply no magic wand which will help it get out of the quagmire. It should also thank its stars that the tobacco industry's bęte noir, Dr. Ambumani Ramadoss, is in limbo, and can therefore do little harm, at least till the next general elections, that is.
Disclosure: Please note that I not a shareholder of this company
This column "Cool Hand Luke" is written by Luke Verghese. Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.
© Equitymaster Agora Research Private Limited