Why ITC Stock is falling? - Detailed Analysis.

ITC continues to underperform but analysts say the stock is attractive. Why?

Hello investors, Welcome to DEV INVEST NOTES and in this article, we will talk about ITC & I will explain why the stock keeps falling.

I already made an article on ITC where I talked about their history and management among other things. I will leave the link above but in this article, I´m going to do something special as you may know, one of their business segments is FMCG that include their cigarette business. I´m not going to talk about their cigarette business. I will only talk about FMCG other.

so I´m going to make an entire article on one small segment and I will cover 5 points.

History, business, updates, financials and valuation

And I´m going to promise you that you won´t find this information anywhere, as you may know, for a very long time, ITC had a very good cigarette business but the managing director noticed that the small shops that sell their cigarette & also sell other products like biscuits and chips.

So they wanted to use this presence to sell other FMCG products and that´s how they launched their first brand, Kitchens of India in 2001, where they sell ready-to-eat Indian gourmet dishes like palak paneer, mutter paneer, pav bhaji, aloo mutter.

Why did they start with this brand? 

As you may recall, ITC owns many luxury hotels and they have their own restaurants in them and this gave them an advantage as they knew what customers are interested in and that´s why they started with ready-to-eat Indian gourmet dishes. They knew what the customer wanted so it made total sense.

But if you look at this FMCG business, they follow two simple strategies and they use it even today.

The first strategy is regarding their brands. They don´t launch many brands. As I will show you later, more than 50 % of their FMCG other revenue comes from only two brands: Aashirvaad and sunfeast.

They focus on strong brands or we can call them mother brands and under those brands, they launch many products. so many times, they will only advertise the mother brands so they subcategories get exposure indirectly, they did the same with Kitchens of India. They started with ready-to-eat Indian gourmet dishes but then they launched chutneys and masalas. And they use this strategy today as well. So you will see some mother brand and many categories under them

The second strategy is the premium products. When they enter a new segment, they start with a premium product and then they enter the affordable segment.

Let me give you 2 examples. The first one is when they entered cookies or biscuits segment, they started with Dark fantasy choco fills, which they launched in 2010.

Britannia and Parle were market leaders and their products were very cheap ( 5 - 10 Rs ) but ITC launched their product at a premium price ( 30 Rs ) and today, they are the market leaders ( more than 20 % market share )  in premium biscuit segment.

 
How did they become market leaders?

There are 2 main reasons. In 2010, biscuits were very boring and vanilla was the most common flavour. ITC launched choco fills and it was something different and their second advantage was packaging. ITC already had a packaging business before so they were good at it and they used their expertise to launch new products. Second example of premium is when they entered the chocolate segment & they launched Fabelle in 2016 but interestingly, it took them 10 years to make this brand.

One of the ingredients needed is sourced from seven countries so they can maintain the highest quality and they actually have a Guinness World Record because one of their chocolates costs 4.3 lakh rupees per Kg.

As you can see, ITC´s revenue is pretty diversified 46 % comes from cigarette and 25 % comes from FMCG other but to be honest, it´s not diversified because 84 % of their profit comes from the cigarette business this is profit before interest and tax & only 2 % comes from FMCG. 

so if you think that the FMCG other business contributes a lot, it´s not true because it barely contributes to their profit before interest and tax and I will show this later when we talk about their financials.

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The first brand is Aashirvaad and it´s famous for their atta, this brand contributes 28 % to their FMCG another category. Let´s try to understand why they started with atta although as I mentioned, they actually started with Kitchens of India. When they started, branded atta consumption was only 5 % of total atta consumption atta is nothing special and it´s basically a commodity because anyone can make it.

At that time, there were only three big players but ITC had a very big advantage their focus was on quality and as they were working with farmers already, this wasn´t so hard, they spent a lot on marketing and they kept adapting their product.

Type of atta kept changing according to different regions and taste and this is how they kept gaining market share and in 3 years, they had 45 % market share and in 2020, they passed 6000 crores in consumer spending. The management has guided for 10 000 crores in the next 3 years.

The market share has changed and in 2018, it was around 28 % in the wheat flour segment, the wheat flour segment is around 17 000 crores and it´s growing rapidly and that´s why big players are planning to enter. One of them is Amul. Amul already works with farmers and they also have an excellent distribution in place so we will see how this goes but as I mentioned before, they start with one brand but they launch several products under it. They also launched salt, ghee and dairy products & their second brand is sunfeast and this contributes 23 % to their FMCG other revenue.

As I mentioned previously, there is brand concentration so more than 50 % comes from these 2 brands Sunfeast is their biscuits brand and they launched this in 2003 – 2004. Interestingly, in the first 5 years, they already had more than 10 % market share and today, this brand has passed 4000 crores of consumer spend.

When we´re talk about Sunfeast, we can´t ignore 1 brand, Sunfeast yippee and this contributes 7 % to their FMCG other revenue and it passed 1000 crores in consumer spending.

There are 2 big players in the instant noodles market : Yippee and Maggi. We don´t have exact numbers but Maggi has more than 50 % market share in Yippee has more than 20 % market share before ITC entered this segment, Maggi had more than 90 % market share.

So, How did ITC gain this market share? Let me explain.

Before entering this segment, they actually conducted some studies on Maggi´s customers. They noticed three points. They noticed that some of the noodles in the market become sticky if they are not consumed early. So they made sure that their product wasn´t sticky. They also noticed that kids like longer noodles so they can slurp, so when ITC launched their noodles, it was round-shaped but the third point is very important. Maggi only had one flavour but they believed that customers wanted more options so ITC launched two flavours: Magic masala and classic masala.

There was a court case regarding magic masala because ITC was using it for their product but Maggi also started using this line. It wasn´t exactly the same because they were using magical masala, so ITC didn´t want Maggi to use this line but the case got dismissed.

Their next brand is Bingo, which is their snacks brand and this contributes 15 %, this brand has passed 2500 crores of consumer spend and they are market leaders in finger snacks. Pepsico is famous for Kurkure but in 2018, ITC passed Kurkure in market share.

So How did this happen?

Between 2007 and 2009, the prices of raw material such as oil and potato was increasing rapidly. But ITC decided to keep the prices stable and they didn´t increase it accordingly plus they increased the content by 50 %. So kukure was increasing the price but ITC didn´t and now they had more content per package and that´s why they became market leaders.

Next segment is personal care and this contributes 9 % to their FMC another segment, as I mentioned before, ITC already had a packaging business segment so they used their expertise to launch new products and gain market share.

Their first brand is Fiama and they sell shampoos, conditioners and bathing bars, it took them 4 years to launch this brand and they are number 2 in this segment with more than 17 % market share and Nivea is the market leader with more than 20  % market share.

Their second brand is Engage, where they sell deodorants. They are number 2 in the overall market and number 1 in the women´s segment and as I mentioned before, they like the premium segment so they have Dermafique, where they make anti-ageing creams.

The fourth brand is Savlon, which they bought in 2015 from Johnson & Johnson, they also bought shower to shower at the same time but Dettol is the market leader in this category.

I have skipped 3 small segments in the FMCG other category and they contribute 14 %, they are lifestyle, confectionary and notebooks ( ‘Paperkrafts’ and ‘Classmates’ ). 

ITC increased stake in Delectable Technologies. This company is engaged in fabricating vending machines so it´s clear that ITC will use to sell more products.

The second point is delivery as you couldn´t purchase their products due to lockdown, so they have come up with innovative ideas like a partnership with Domino´s, they have updated their website and they have store on wheels.

So they have come up with good ideas to sell their product and the third point is innovation. They are launching a new product every 15 days, especially for the current situation

So mainly it´s hand sanitisers under Savlon & they also launched Nim was as fruit and vegetable wash.

let´s start with their revenue

Please remember we are still talking about FMCG other, I started from 2003 because this is when they launched, & they went from 109 crores to 12844 crores.

Technically, you will think that they are growing rapidly but this doesn´t give you the complete picture.

Here the revenue growth in percentage, the growth is compared to the previous year, it was higher when they started as it was small. So it went from 500 % to 80 % in the initial years but after 2016, it´s in single digits.

It increased a big in 2018 and 2019 and in 2020 it was 5 % excluding lifestyle, notice that the revenue growth is slowing down, we can understand it because the size is getting bigger but now let´s check their profit before interest and tax. It was in loss for several years but it became profitable after 2014 and this reached 424 crores in 2020.

But it´s important to check their margins, it was negative before and now it has reached 3 %, this point is very important because now we know that the growth is slowing down & the margins are very low as well and I always like to check the Return on capital.

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Please remember we are still talking about FMCG other, it was negative initially but now it has reached 6 & It is 6 % is very low compared to other companies but I´m going to explain the reason behind this and I´m going to explain that in the next segment.

Normally, I would talk about free cash flows but the entire article is on just a small segment of ITC, so I can´t share free cash flows of it but I can mention some points. The first point is sector. Nearly 70 % of the products launched by FMCG sector don't make the cut after the first two years in the case of ITC, they are launching a new product every 15 days and that means they are investing in their brands and that´s why the return on capital was so low.

When you look at the capital of a business, you are looking at 2 simple points, first, you look at the core business and you try to understand if the earnings are good or not, as I mentioned before, 84 % of their PBIT comes from cigarettes, which is growing in single digits and is pretty stable and in the second point, you see how they invest the money they are getting from their core business and in my course I teach how to study these businesses and how to check their returns.

In ITC´s case, the return on the cigarette business is very high but it doesn´t require investments and that´s why ITC gives you such a good dividend, which I think is a good sign because they care about their shareholders and a big chunk of the capital left is invested into FMCG other but unfortunately, this requires a lot of capital and it takes decades to establish a brand and only then you will get good margins and returns and that´s why you don´t see good margins and returns and when you look at consolidated numbers, you will see the growth is very low.

CAGR revenue. 

CAGR revenue growth for the last 5 years has been below 5 % profit growth is around 10 % but because of higher margins and lower taxes but overall growth is muted and that´s why you get the company at such cheap valuation, mainly because the growth is muted.

So it´s a good company or a nice dividend but if you want the stock price to go higher, you need the revenue to grow faster & if you want many reports on several companies then comment below and don´t forget to subscribe for more articles. If you are liking this article and share it with your friends and family and let me know the topic of the next article in the comment section. And you can visit our official website WODS OFFICIAL.

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