ITC: A demerger on the cards?

By Angel Broking | Published on 22nd February 2021 | 4811

ITC: A demerger on the cards?

India’s largest cigarette maker, ITC Ltd, is back in the news again over talks of a demerger of its FMCG and hotel businesses. Talk over its demerger has done the rounds in the past as well but the recent earnings report of the 110-year-old giant is again giving rise to such speculation.

The conglomerate that operates several brands as part of its cigarette, FMCG and hotel segments reported a consolidated net profit of Rs 3587 crore for the quarter ended December 31, a drop of 11 per cent from its net profits in the same quarter last year. EBIT (Earnings before interest and tax) for cigarette business dropped 8.68 per cent for the quarter, while the conglomerate recorded a 125 per cent rise in EBIT for the non-cigarette FMCG segment at Rs 243.17 crore compared to the same quarter a year ago. Revenues from the hotel segment dropped 57 per cent to Rs 248.8 crore for the quarter, and the hotel segment recorded a Rs 72-crore loss, which is lower than the loss of Rs 193 crore in the quarter ended September.

The easing up of restrictions and growth in mobility were attributed to the lower losses in the hotel segment and also the cigarette business compared to the previous quarter. The Q3 standalone revenue was up 4.9 per cent year on year for ITC on the back of its FMCG and agribusinesses.

Rollercoaster for the tobacco segment

It may be recalled that the ITC stock had rallied during the Budget week, surging nearly 18 per cent for five trading days following the absence of any announcement in the Budget that would affect taxation for the tobacco segment. However, a new draft bill that proposes to increase the smoking age to 21 may be a potential risk for ITC. Also, in the recent past, tobacco stocks have been under stress owing to environmental, social and corporate governance (ESG) concerns, which has meant a  drop in price to earnings ratio. ITC has continued to be known as a cigarette marker largely, with cigarettes accounting for a little over 46 per cent of its revenues for the year ending March 2020, and bringing in 85 per cent of its operating profits, according to media reports.

Focus away from the cigarette segment; shift to FMG

However, reports suggest that ITC’s need to shift the spotlight away from cigarettes has grown over the years. During the early part of the Covid-19 related lockdown, cigarette production came to a halt in some places and supply was hit. And yet, over 74 per cent of the company’s standalone pretax profit came from cigarettes, although a drop from the same time a year ago. But on the sales front, the April to June 2020 period saw a 30 per cent drop y-o-y in the sale of cigarettes.

In the year of lockdowns and the pandemic, ITC launched 70 products in the FMCG (non-cigarette) space to tap into the potential of the pandemic-induced consumer needs. All these launches were made in the first half of the financial year and were largely in the wellness and convenience space, and overtook the launches ITC had made in the whole of 2019-2020. In the latest earnings announcement, the company said it launched over 100 products in the last nine months in the FMCG segment.

In the quarter ended September too, the non-cigarettes FMCG sector got a shot in the arm, posting its highest quarterly revenues of Rs 3795 crore. The pretax profits for the FMCG segment rose 66 per cent in the quarter ended September 30, 2020. Meanwhile, the cigarette business saw a y-o-y drop of 14.4 per cent in its net revenues, although sequentially it was up 33 per cent.

The rise in the FMCG sector, with ITC’s personal care /hand sanitiser and soap brand, hit Rs 1,000-crore in terms of consumer spending for 2020 during the quarter ending December 2020.

All these (the strong FMCG results and a weakened cigarette and hotel business) have led to the talk of a demerger gaining credence. In September 2020 too, media reports suggested that ITC would examine an “alternative structure” for its hotels business although it has clearly emerged whether it would actually mean a demerger. More recently too, the ITC chairman spoke of reviewing the need to create alternative structures for the hotel business.

Demerger: Repercussions

Dividing the company into the FMCG and tobacco or even trifurcating the company into three, with the hotels business bringing up the third part may generate greater shareholder value. In a scenario where one segment such as FMCG is booming, the shareholder value rises in that segment. Demerging the FMCG segment would attract new funds as well and therefore investment opportunities. A planned and well-timed demerger is vital. This is because, for instance, when the economy opens up post-vaccine rollouts and a peak immunity level has been achieved, the hotel segment may see a sudden uptick bringing much-needed investor interest in that segment. A demerger also helps the segments compete better with peers rather than one segment tugging back the value of the entire company.

Conclusion

The recent statements by the ITC Chairman regarding restructuring the hotel business along with earnings announced by the 110-year-old conglomerate that shows FMCG registering impressive results have triggered talk of a possible demerger. A demerger if strategically done will benefit shareholders and boost investment. Timing, however, is of the essence.