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Do the 'ITC's of Your Portfolio Have Upside?

Jul 26, 2023

Do the 'ITC's of Your Portfolio Have Upside

They are not your favourite stocks.

You certainly have no dreams of holding on to them for decades.

But these are not stocks that you hate having in your portfolio either. You are not looking forward to sell these stocks with marginal profits.

These are stocks that are constantly in the news but offer very little comfort.

In short, stocks that have a history of long term under performance are the focus of only meme creators.

For investors, such stocks become the nagging doubt in their portfolios across market cycles.

ITC became the quintessential example of a meme stock, ever since the stock underperformed its peers in the post Covid rally.

ITC was not new to such phases. In fact, over the past two decades, the stock has regularly spent years in hibernation, giving investors the jitters about holding it.

So much so that over time, other underperforming stocks and sectors were referred to as 'the ITCs'!

Sometimes they were the technology stocks.

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Sometimes auto.

Sometimes banking and even food delivery businesses.


From time to time, the stock has been weighed down by negative perceptions.

Excessive government regulations on its tobacco business, poor allocation of capital, low shareholder returns were all reasons why investors evaded the stock.

Also, there was a long held belief that the company was underutilising its cash reserves.

This negative sentiment overshadowed the company's strengths in its FMCG and other growth businesses.

However, a series of strategic moves and a renewed focus on growth have gradually turned the tables.

In fact, ITC's recent outperformance has kept the stock in the limelight.

What is most shocking is the fact that the periodical stagnation in the stock price did not stop it from beating the benchmark Sensex nearly 3x over past two decades.

Also, its latest move to demerge the hotels business could also unlock value over the long term.

Temporary Underperformances Didn't Stop ITC from Beating Sensex 3x


Now, ITC is not the only stock that has had long periods of underperformance and has tested the patience of investors.

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In fact, investors are often in quandary about whether to hold on to the 'ITC-like stocks' in their portfolios.

So here is a basic checklist to evaluate such stocks...

  • Evaluate Intrinsic Value vs Market Perception

    ITC currently has over 120 hotels across over 70 locations.

    However, the market perception about the conglomerate's hotel business segment is that it has been a cash drain.

    The high capex on the hotels business and the resultant subpar returns were reasons why the management sought an alternate structure.The hotel business contributed less than 5% of ITC revenues and operating profits over the last decade. However, it accounted for over 20% of the company's capex.

    However, after the demerger, ITC Hotels will become the second largest listed hotel company by rooms. As shared in the demerger note, here are the stats...

    • Indian Hotels - 21,338 rooms
    • ITC Hotels - 11,600 rooms
    • Lemon Tree Hotels - 8,400 rooms
    • EIH Hotels - 4,269 rooms
    • Chalet Hotels - 2,634 rooms

    Post demerger, ITC will continue to hold a 40% stake in ITC Hotels. The balance will be held by the company's shareholders proportionate to their shareholding in ITC.

    Therefore, while the market perception may be that the demerger may not meaningfully unlock shareholder value, the intrinsic value of the hotels business seems to be potentially much higher.

  • Don't Ignore Fundamentals

    A company's worth is not understood predominantly by how its share price has moved.

    Rather by its ability to generate and sustain free cash flow in the future which in turn depends on profitability, reinvestment, and longevity of the business.

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    In fact, empirical evidence points to the fact that over the long run, stock prices are driven by the company's fundamentals.

    In the case of capex heavy stocks like ITC it is important to keep a watch on the level of debt both at standalone and consolidated levels.

    Remember, excessive leverage has brought in existential crisis for conglomerates like Zee.

  • Don't Price in Value Unlocking Upside

    Many ITC-like large conglomerates and holding companies have massive value unlocking potential over the lifetime.

    The possibility of gains from the stocks, once the subsidiaries become profitable and get listed, keeps investors hooked.

    However, in the meanwhile, such stocks keep getting valued at a 'holding company' discount.

    The biggest mistake most investors make in buying such stocks is paying a hefty premium to earnings, for pricing in the value unlocking potential.

    Initially, ITC's decision to demerge the hotels business was received with stock market frenzy.

    However, eventually market participants paid attention to the fact that tobacco and FMCG segments account for 80% of ITC's revenue. Hotels contributed just 5%.

    So, to expect that a capital-intensive hotel business will immediately create shareholder value for ITC, on demerger, is unrealistic.

  • Be Patient About Near-Term Hiccups

    As a conglomerate ITC has always attracted criticism for capital allocation.

    Be it entry into hotels in early days or paper board and agarbatti later, the company's efforts to diversify from tobacco, did not pay off for years.

    ITC had flagged its decision to explore alternate structures for its hotels business in its FY20 annual report. This was subsequently delayed by the pandemic.

    During the pandemic, the company's hospitality business (especially luxury hotel chains) suffered to a great extent. All this drew additional criticism from shareholders. The decision was to offload such asset-heavy businesses that are bleeding cash.

    Well, since then, the narrative has changed. ITC's hotel segment witnessed a remarkable recovery in financial year 2023 on the back of the wedding season, leisure and business travel.

    The fourth quarter of FY23 was very strong where it almost doubled revenue and profit.

    Therefore, while the proposed demerger could ensure sustained value creation and synergies, investors need to be patient about near term hiccups.

  • Be Disciplined About Sell Criteria

    It is important to have a clear sell criterion for stocks which have had a history of unfavourable capital allocation.

    While valuations and business tailwinds may act in favour of the stock over long periods, poor governance can be a deal breaker.

    ITC-like laggards in your portfolio could potentially offer you as much as 3x the Sensex returns when held over decades.

    However, ensure you run through this checklist to evaluate whether at all you should hold on to the stocks.

Warm regards,

Tanushree Banerjee
Tanushree Banerjee
Editor, StockSelect
Equitymaster Agora Research Private Limited (Research Analyst)

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