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ITC Ltd | A Value-Trap or a Real Bargain?

Let's checkout one of the most talked about stock in the investing community as of March 2020, ITC Ltd. Currently there are many prominent investors who believe that the stock looks undervalued at Rs. 150~ and might prove to a good bargain opportunity.


Established in 1910, ITC is the largest cigarette manufacturer and seller in India. ITC operates in five business segments at present — FMCG Cigarettes (since inception), FMCG Others (since 2001), Hotels (since 1972), Paperboards, Paper and Packaging (Since 1977), and Agri Business (since 1990). The company is the proud owner of one the best brands in India like:

  • Consumables - Aashirvaad, Sunfeast, Bingo

  • Cigarette - Goldflake

  • Personal Care - Fiama, Vivel, Engage, Savlon, Charmis

  • Education - Classmate, Paperkraft

  • Matches and Agarbatti - Homelites, Mangaldeep, AIM

  • Hotels - ITC Kohenur, ITC Maurya

Its of no doubt how good is the management in terms of innovation and coming out with new products under various brands. The management is indeed capable of bringing out new innovations from time to time. Apart from some capital misallocations, its seems fine with how ITC is kept under the hands of a capable management.



Let's turn our attention towards the financial aspects of the company. In the end, it's all about the numbers. For starters, let us look at the general company facts -

We notice how the revenues are growing from the past 10 years and they are not very encouraging. Revenues have shown a growth of around 6.5%~ from March 2010. Its profits on the other hand have grown at 12%~ for the same period. We see such a deviation mainly because of the improvement in profits margins. More on that later.

ITC Ltd. earns about 90% from its core operations and about 10% from its Other Income sources like interest income and dividend income. If you observe carefully, the company incurs capex expenditure which is more than 2x of what it reports as depreciation. This is mainly because the company is consistently investing back into the business like ITC's hotel business which is cash heavy and more importantly because it has to incur capex in order to maintain its huge asset book. (Note: We will shortly blog about how inflation can make depreciation numbers look small and increase reported profits which more often than not, do not reflect the true earnings of the company)

ITC's asset structure is mainly comprised of Investments (42%~ as of March 2019) and Net block (33%~ as of March 2019). The company has parked around 50% of its investments or 21% of its balance sheet in quoted debentures and bonds and the rest investments are kept mainly in Unquoted units.

Company's average inventory cycle seems to be improving from 273 in March 2010 to 159 days in March 2019. Although the company's payable cycle has shortened along with increasing collection cycle, ITC has managed to reduce its net working capital cycle from 183 days in March 2012 to 116 days in March 2019.

ITC incurs fixed costs of roughly 15%~ as compared to its variable costs. The company manages to earn roughly 6%~ on its investments (non-core). The company has been able to earn roughly 20%~ core net profit margins over the past 10 years. ITC has seen a decline in its return on assets (suggesting under-utilisation) from 29%~ in March 2010 to 21%~ in March 2019.

Analysing ROE further, we see that it actually worsened in ten years from 30% to 21%~ as per latest. Company's asset turnover reduced significantly from 134%~ in March 2010 to 80%~ in March 2019 further strengthening our case of incorrect capital allocation.


Comparing PNL with Cash Flow statement, we see that the company does earn cash against its reported profits. This is one small glimpse of how we check for accounting fraud and whether the company is actually earning cash (unlike Reliance Industries - coming soon) against its reported PNL. We do see that ITC generates almost the same amount of cash as it reports on its profit and loss statement as confirmed by Cash Generated from Operations / Operating Income and (EBITDA - Tax) / CFO. We ran a few more tests and we do not see any major red flags about manipulation that need to be questioned.



What really concerns us is the low growth that the company is experiencing apart from some incorrect capital allocations denting the real profitability and potential of the company. Further addressing the low growth rate issue, let's look at breakup of how its product segments are performing in terms of revenue contribution:

The Cigarette business is the slowest to grow @ 3.10% CAGR over 10 years (contributing 45%~ to total revenues) followed by Hotels and Paper boards @ 7.5%~ each. Personal care, consumables etc. are growing at a rate of 10.64% which are contributing 7%~ to total revenues (although still below industry growth rates for such goods). Branded packaged foods is the fasted growing category with an impressive growth rate of 17.2%. We should not forget the FMCG, though inelastic, is a competitive domain with brilliant companies trying to capture the market share.

We believe that since humans tend to be over-optimistic and bad forecasters, we do not try much to predict what will happen in the future and let history dictate us (of-course, we rigorously check whether this history which we are saying should repeat in the future is backed by strong evidence and hardcore facts). We avoid those areas where extensive human forecasting is required. Continuing this belief, we see ITC not improving its growth rates drastically unless better capital management and allocation emerges. ITC continues to be on our watchlist, its a good stock with a low amount of risk (good for conservative investors). We will, however, not invest in ITC for now as we do have many more opportunities in the market with much better growth rate, lower risk and bright prospects.   



Please refer to the below graph:

The above graph represents the period from 2010 to 2019. The BLUE line is the market price of ITC Ltd. and ORANGE line suggests our fair valuation range. It suggests we buy this stock around Rs. 150~. According to our models, we only got the opportunity to buy this stock twice, once in April 2010 and the other in March 2020. Yes, it may look absurd that we are giving such low valuations to a quality stock but we have outlined our reasons why we think we have better opportunities placed in the market. ITC is a great stock to hold from risk perspective (safe stock) but its just not that attractive for us to buy

It is a great stock to hold for the long-term from risk perspective although we don't think t will be able to generate good returns mainly due to concerns regarding low growth rate. As a result, there are much better opportunities currently available in the 2020 bear market which are in line with our views and help us manage our risk accordingly. We decide not to invest in ITC Ltd as of March 2020 but shall continue to track this stock actively.



Let us know how we can improve your investing experience and whether we should post such analysis more in-depth or keep it short.

Happy Investing!

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Anirudh Jindal
Anirudh Jindal

Hi Rajesh,

CGO - Direct taxes = CFO. These numbers are directly consumed from a reliable database provider who collect this data from ITC's annual report.

Apart from comparing PNL profit with cash profit, we perform many other accounting checks like comparing depreciation and average capex rate, checking if any incorrect adjustments are being posted into reserves, inventory fluctuation levels, growth in auditor expenses etc.


Rajesh Sharma
Rajesh Sharma

Hi In this analysis, from where did you arrive CFO and CGO values and what is difference in these two items.

Further, What other accounting checks do you run while checking manipulations. Thanks.

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