October 21, 2020 - 7:03am EST by
2020 2021
Price: 168.00 EPS 11.50 12.75
Shares Out. (in M): 12,306 P/E 12 10
Market Cap (in $M): 28,200 P/FCF 14 12
Net Debt (in $M): -4,968 EBIT 2,400 2,600
TEV (in $M): 23,230 TEV/EBIT 10 9

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ITC is a 110-year old Indian branded consumer company, that is currently unpopular and available at a 10% free cash flow yield and a 5%+ dividend yield, despite a great long-term track record, strong brand recognition (ITC products reach over 150mm households in India) and future reinvestment opportunities (60+ new product launches in 2019-20), while its core cigarettes business has muted growth but generates significant free cash.

The company has grown revenue at 10% CAGR over the last decade and has grown revenue every year, even if growth has been low single digits recently. ITC has grown profits at nearly 14% CAGR over the last 10 years, including growing EPS 17 out of 18 years.

ITC consistently generates  free cash flow, the last five years between US$1-1.7bn. The company's business model is relatively capital light, ITC generates approx $3-5 in operating cash for each dollar of capex over the last 20 years.

Over the last 15 years, the company consistently meets the Rule of 40, i.e. even though growth rates are low now, margins are still quite high. 

The company's unlevered return on tangible equity is over 40%, even during financial crisis periods, well in excess of its cost of capital.

Returns on incremental capital over the last 20 years have consistently been over 30%, including double digit positive incremental returns on capital during the last financial crisis, a clear sign of the company's moat and resiliency of its business.

The balance sheet is strong representing nearly 18% of its market cap in net cash and long-term investments. This means that even if sales were to be $0 (which would never happen), assuming opex was 50% of current levels, the company would still survive for nearly 2.5 years. 

The company has pricing power as evident through its consistent and stable gross margins in the 60s and EBIT margins in the 30s. It is a small spend for customers, which means repeat purchases.

The company has over the long run, paid out nearly 70% of its free cash in dividends and repurchases, with limited outside capital raise. Quality of earnings has been good, with cash flow consistently higher than accounting earnings.

To be clear, this is not a high growth stock, but a deep value stock in an otherwise exuberant market, fueled by low rates, money printing and companies being rewarded for high growth (at all costs).

ITC stock has fallen nearly 30% this year, and this means that current valuations are approx 10% free cash flow yield and high single digits ex cash earnings multiples. This is cheap for a business that has 40%+ ROE, generating free cash consistently and has grown revenue over the last 20 years, even if growth has been sluggish recently, the odds of future reinvestment opportunities in its FMCG business are good.

Bottomline, ITC can be expected to conservatively at 15% a year, with limited downside and potential for several upside catalysts, including growth opportunities from its FMCG portfolio with improving return metrics, increased dividend payouts (has increased to 80%) given the cash pile and historical record, improving distribution and e-commerce channel monetization and value as its own catalyst. 

Risks (opportunity cost) for the stock, include anemic growth over the next 3 years, an extended lock down in India due to COVID extending for another 12 months, ESG considerations for foreign institutional investors. Downside for the stock at current levels is low, relative to its intrinsic value.

Business Highlights

ITC's cash cow business, cigarettes in India, has over a 75% volume share, enjoying significant competitive advantages. The company's FMCG products division (non-tobacco) reaches over 140 million households in India.

FMCG of ITC has grown 4x in the last 10 years, and it is today the 3rd largest FMCG company in India. The addressable market is large, over the next decade or so, ITC expects snacks to grow 4.5x, branded atta 4x, spices 5x, biscuits 3x, noodles 4x, and handwash & bodywash ~8x.  With 6 out of 11 brand in packed food are in the incubation stage, ITC needs to continue investing to build these brands. ITC has created 25 powerful brands with Top 1-2 positions, some of which have reached significant scale (Aashirwaad, Sunfeast).

The focus is on innovation (premiumization, health & hygiene-led) and trying to be he first-to-market. The company launched 40 new products during the pandemic and supply chain (pushing inventory closer to demand centers) further led to strong growth.

Within a relatively short span of time, ITC has built 25 mother brands, many of which are market leaders in their segments

During the year, ITC also launched over 60 new products some of which are shown below