ITC share ‘buy’ or ‘sell’; CLSA believes long-term positives unfolding with FMCG driving value

Shares of FMCG major ITC continue to move higher for the second-day straight after global brokerage and research firm CLSA upgraded the stock to a ‘Buy’ rating. Shares of the cigarette-to-hospitality giant have disappointed shareholders since June this year, clocking in a 13% fall in the share price while the benchmark S&P BSE Sensex has gained over 20% in the same period. CLSA in its report said that ITC’s FMCG segment is set to become a major value driver, with the company’s legacy cigarette business providing the cash to meet its ambitious goals. CLSA has a target price of Rs 220 on the scrip which translates to a 27% upside from current price of Rs 173 per share.

FMCG business at the cusp of growth

“We upgrade ITC to BUY as we believe the market is ignoring long-term positives. We expect a K-shaped acceleration for the FMCG business with a profitability focused approach and benefits of scale driving a sharp acceleration in margins, while incremental capital intensity falls,” the report said. CLSA believes that FMCG business of ITC is set for accelerated growth, mainly in foods, which make up 81% of the segment. To fund this growth, CLSA says, ITC’s cigarette segment will pitch in. “Despite multiple headwinds, the cigarette business has maintained strong free cash flow generation which should continue to help the FMCG business meet its goals,” they added.

Addressing the key concern of lower margins in some of ITC’s offerings, that investors have had, CLSA said that the benefits of ITC having incubated a much larger category basket compared to peers, an improving sales mix, falling incubation costs, operating leverage benefits, and its ability to move into new categories with limited incremental investment, offsets some of these concerns. The FMCG business is estimated to grow at 11 CAGR till fiscal year 2023. In financial year 2008, the revenue breakdown of ITC’s FMCG revenue saw staples take 29% of the pie, lifestyle having 27% share and biscuits having 24% stake, among other products. In the last fiscal, while staples continued to be a big part of the revenue basket, lifestyle has shrunk and other products have taken a piece of the pie, helping ITC diversify. The firm has 24 FMCG brands.

ESG concerns easing

CLSA added that in the past, ITC’s derating was a factor of ESG-related concerns, regulatory tightening, capital allocation and Covid-created uncertainty. “Most of these concerns are set to be addressed as the FMCG business is at an inflection point and capital allocation issues are being addressed,” they added. CLSA expects ITC’s FMCG business to deliver about 30% Ebitda growth by 2023. 

Risks aligned 

“Valuations at 6.5x FY22 implied PE for the cigarettes business are now one of the lowest globally (a 30% discount to the global peer average),” the report said. CLSA sees the cigarette business trading at a 55% discount to 10 year average PE while FMCG and Hospitality businesses trading at discount to peers. A sharp rise in cigarette taxes stands as a key risk to the call along with a prolonged shutdown which may damage cigarette business volumes.