The rally after the budget in ITC Ltd shares, as it turned out, was flattered to deceive. ITC shares jumped over 15% in the budget week after the government left cigarette taxes untouched. But the stock gave up over half of those gains last week, part of it due to weaker-than-expected December quarterly results.
The stock is trading around $217 pieces crumbling below its pre-coveted heights a year ago. Other consumer inventories exceeded their pre-covid heights several months ago. While ITC’s underperformance is not new, investors remain confused about the extent to which the stock is lagging behind. Other delays such as the State Bank of India and Larsen and Toubro Ltd have recovered sharply in the so-called reopening rally since the end of October, rising 107% and 64% respectively. ITC’s recovery in the same period has been far more modest at 33%.
“ITC is a security and will probably remain a value purchase forever, it seems,” says a fund manager.
Note that ITC’s annual profit is more than double that of Hindustan Unilever Ltd (HUL). But its market value is exactly half of HUL. Varun Singh, an analyst at IDBI Capital Markets and Securities Ltd, said, “HULs Ebitda increased by a compound annual growth rate (CAGR) of 13% in FY15-FY20 against 6% Ebitda CAGR of ITC. If HUL grew Ebitda more than twice as high as revenue growth, I would say it has done very well to make the cost of execution cheaper. This trend is not visible in ITC with similar intensity. “Ebitda is earnings before interest, tax, depreciation and amortization.
ITC’s relatively slower long-term growth prospects also control valuation. An analyst at Emkay Global Financial Services Ltd says: “For ITC, unfavorable government regulations, reduced affordability of cigarettes and a huge market for illegal cigarettes have weighed up volumes in the past.”
In addition, environmental, social and governmental concerns (ESG) have in recent years posed a major threat to global tobacco stocks. “In line with this, ITC has experienced a large outflow of foreign funds. Just about three years ago, the ITC stock traded at about 25 times a year’s futures earnings, and now the stocks are trading 15 times, ”Emkay’s analyst pointed out.
In the past year, subdued cigarette volumes in the midst of lockdown are a factor that weighs against emotion. The results for the quarter in December are not inspiring either. Analysts estimate that cigarette volumes fall by approx. 7% last quarter. Plus, ITC’s growth in FMCG revenue is moderate in line with pandemic – related tailwinds.
Shyam Sekhar, co-founder of iThought, an investment advisory firm and shareholder, said “Another problem is that they choose a less efficient method of giving back to shareholders by giving dividends instead of making a buyback.” The ITC declared a temporary treatment benefit of $5 pr. Stock, which marks a departure from the past, as it only distributed once a year. “Given the reduction in valuation multiples due to the ESG, one way it can increase investor confidence is by making a buyback.”
Investment analysts Michael J. Mauboussin and Dan Callahan point out in a Credit Suisse note titled Payment of cash to shareholders, “Repurchases continuously benefit shareholders when management buys shares that are undervalued, and benefit outgoing shareholders when the share is overvalued. Since management should focus on building value per. Stock for continuing shareholders, it should always try to buy back shares that are undervalued. “
Analysts at JM Financial Institutional Securities sum up the outlook for the stock well: “The stock is likely to remain subdued given the absence of a solid business trigger so far. Valuations are cheap compared to other stocks in the sector, but that reason alone is unlikely to help the stock go higher in the absence of growth or narrative. “
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