Indian Tobacco Company Limited (“ITC” or “Company”) has been one of the biggest wealth creator in the Indian stock markets, over the past many years. In the last 10 years alone, ITC’s stock price has increased by over 1200 %. Besides being a professionally and competently managed Company, ITC operates in the highly lucrative and ever growing cigarette industry. The future growth prospects of the industry are highlighted by the ‘Census India 2011’ data, whih estimates that roughly 100 million people will attain the age of 18 in the next 5 years, which is the minimum legal age to purchase or smoke cigarettes in India.
With an 80% domestic market share (i.e. ITC manufactures 4 out of 5 cigarettes consumed in India), and given the brand recognition of its cigarettes, ITC is well placed to benefit from this exponential growth.
The biggest worry for ITC may be that various anti-smoking lobbies around the world have been working towards discouraging people from smoking and have gained particular momentum over the last few years. In 2004, the government imposed restrictions on advertising of cigarettes. In 2008, a ban was imposed on smoking in public places including restaurants and hotels. Further, the government attached graphic health warnings on cigarette packets from 2009 which have only become more deterring in recent times. In December 2012, a bill was introduced in the Indian Parliament to adopt plain packaging for cigarettes, which means that in addition to the graphic pictorial warnings, manufacturers will have to sell cigarettes in plain paper packing with no company or brand trademark and without any fancy logos or slogans.
In order to de-risk its revenue model by reducing its reliance on cigarettes and to move away from being branded as a pure cigarette Company, ITC has been expanding rapidly in the FMCG (non-cigarette) segment and has indeed created some landmark brands such as Aashirwad atta, Sunfeast biscuits, Fiama di Wills, Vivel soaps, Candyman…and the list could go on. To strengthen its presence in the hotels space, the Company has acquired a 14.98% stake in EIH Limited which operates the Oberoi Group of Hotels and holds a 12.88% stake in Hotel Leela Venture. In the retailing space, Wills lifestyle and John Players have become fairly well known brands. The education and stationary business is consolidating its market leadership position with ITCs ‘Classmate’ and ‘Papercraft’ brands.
Based purely on the visibility of these brands, ITC does appear as an extremely diversified corporation. However, a closer look at the financial highlights that ITC continues to generate a majority of its revenues from cigarette sales. In fact, if we compare the current revenue from cigarette sales with the same for the year 2006-07 (i.e. 5 years ago), there is hardly any change in the renenue stream. This, despite the fact that over the last 5 years, the Company has created all those landmark brands.
Compare this with the figures for FY 2006-07, where total revenue from cigarette sales stood at ~ 57%, and cigarette sales contributed ~ 82% to the Company’s segmental profit. Does it impact a shareholder in any way? Probably not. Unless, even more stringent anti-smoking laws and regulations are imposed. So far it appears that none of the regulations and tax rates on cigarettes have had much impact on the ever growing cigarette sales. This trend, we believe is unlikely to change at least in the near future (i.e. 5-7 years). Unless, of course there is a complete ban on the sale of cigarettes.
In this backdrop, ITC remains a robust company with strong fundamentals, diversifying rapidly into various sectors. For long term buyers, valuations aside, it may be worthwhile to keep a close watch on the regulatory environment and the Company’s revenue streams.