British American Tobacco: The Hidden Value Of ITC Limited
Summary
- British American Tobacco's massive stake in ITC Limited is an often overlooked catalyst that has the potential to significantly increase shareholder value.
- ITC Limited has been performing really well and its cigarette business has been thriving amid the ban on e-cigarettes and the relatively loose regulations of tobacco.
- A potential divestment could substantially increase financial flexibility and provide more dry powder for debt repayments or share buybacks.
- The latest update came in much better than feared, as the company reaffirmed its revenue and EPS guidance for FY23.
Altayb/iStock via Getty Images
Investment Thesis
After publishing my recent article on British American Tobacco (NYSE:BTI), I noticed that many investors seem interested in knowing more about ITC Limited. For those who are unaware, the company currently has a significant 29.1% ownership in ITC Limited. As ITC's share price continues to rise, its market cap has grown to $66.6 billion, making BTI's stake worth a massive $19.4 billion, or roughly 27% of its current market cap. Considering its increasing presence, I have decided to write a more detailed article about the company and its value in regard to British American Tobacco.
Market Screener
ITC's Backdrop
ITC Limited is an Indian multi-conglomerate company listed on the NSE (National Stock Exchange of India). Since going public in 1999, its share price has increased by a whopping 2,500%, making it one of the best performers in the Indian stock market. It has also been consistently returning cash back to shareholders through dividends, with the latest yield standing at 2.88%.
The company operates in multiple industries including cigarette, packaged food, hotel, agriculture, and paper. Cigarettes are by far its largest segment, accounting for around 42.7% of total revenue. ITC currently has the leading cigarette portfolio in India, with notable brands such as Gold Flake, Wills Navy Cut, and others. The market opportunity for cigarettes in India is massive, as the country has the world's second-highest number of tobacco users at around 270 million adults, according to Financial Times.
Unlike most cigarette brands in other countries that continue to see a decline in popularity, India's cigarette brands have been holding up very well, as regulations remains relatively unchanged in the past decade. As you can see in the graph below, the popularity of ITC's Gold Flake has been slowly rising in the past few years. The increasing popularity is also shown in the company's financials, with cigarette revenue growing by 20.3% in the latest fiscal year.
Google Trends
Failed Takeover
In order to gain control of the cigarette business and capture the growth opportunities in India, British American Tobacco had tried to raise its stake and take over ITC Limited in the past. However, this did not work out as the India Government has a very strong stance on foreign ownership of Indian companies. For instance, nearly 30% of ITC Limited is currently owned by state and government-controlled companies. I believe this is why the management has been pretty much silent about ITC, as their hands are basically tied by the India Government with nothing much they can do.
The Economic Times on BTI's attempted takeover
As for the core tobacco business, London-based BAT has tried in the past to raise its stake and take over the cigarette maker, but local managers have seen it off using Indian financial institutions' voting power. Now, BAT can't even try to mount a bid for all of ITC because tobacco has been made off-limits for foreign direct investment since 2010. That, too, was done to keep ITC in Indian hands.
Will The Company Sell Its Stake?
Due to ongoing government intervention, I believe the company will likely consider selling its stake, especially with ITC's share price now trading at an all-time with an elevated PE ratio of nearly 28.7x. The divestment will also give the company a lot more financial flexibility moving forward.
The company has been criticized for its elevated debt load, and this massive one-time proceed is an efficient way to quickly deleverage. For instance, the company should be able to decrease its outstanding debt by half if it uses all the proceeds. The debt-to-EBITDA ratio will also drop sharply from 3.2x to 1.6x. Besides, the company may also be able to restart its buyback. This is extremely beneficial to shareholders as it allows the company to leverage the depressed share price and retire as many outstanding shares as possible.
Other than financial incentives, India's value also does not align with British American Tobacco's smoke-free blueprint and ongoing transition to reduced-risk products or RRPs. Unlike most countries, India has not really tightened its regulation on combustible products in the past decade. However, the country established a law in September 2019 that completely banned the production, manufacture, import, export, transport, sale, and distribution of e-cigarettes (including heated tobacco) and their components.
While some people are still able to access e-cigarettes through grey channels, the adoption rate is still extremely low. According to The Lancet, the adoption rate of e-cigarettes among adults over 15 is 0.02% in India, much lower than in other countries, as shown in the chart below. This makes it nearly impossible for BTI's RRP products to enter the market, even if they are able to leverage ITC's best-in-class distribution channel. I believe the lack of RRP expansion opportunities makes India now a less-prioritized market for British American Tobacco.
The Lancet
HY23 Update
British American Tobacco also recently announced its trading update for the first half of FY23. Despite facing a tough macro backdrop, the company still reaffirmed its full-year guidance, which is encouraging. It continues to expect constant currency revenue growth of 3% to 5% with mid-single digit constant currency adjusted diluted EPS growth. The 4% revenue growth at the midpoint is actually 29 basis points higher than my projection in the previous article. The company now expects global tobacco industry volume to be down 3% (previously 2%), but still much better than my projection of 5%.
RRPs continue to see great momentum globally. Vuse's value share grew 280 basis points in key vapor markets while Velo's volume share grew 70 basis points in key oral markets. glo's performance was relatively disappointing, with volume share down 110 basis points in key markets.
Tadeu Marroco, CEO, on glo's performance
glo has had an underwhelming start to 2023, albeit recent momentum is more encouraging. glo Hyper Air is a step forward in what promises to be an exciting pipeline ahead.
Investor Takeaway
As mentioned in the previous article, I believe ITC Limited is an extremely valuable asset to British American Tobacco, no matter if they decide to sell their stake or not. I am more inclined towards them divesting it, as the massive proceeds should significantly enhance shareholder value through share buybacks and debt repayment.
Even if they do not, ITC should still continue to provide solid value. For instance, British American Tobacco is receiving nearly $540 million in dividends alone each year, which goes straight into the bottom line. ITC should also continue to see strong growth in its cigarette business amid the ban on e-cigarettes and the relatively loose regulations on tobacco.
The latest update also shows the resiliency of the company as the result came in much better than most feared. Overall, I believe the recent fear shown in the share price is exaggerated and investors should pay more attention to ITC moving forward, as the company could become a potential game changer for British American Tobacco.
This article was written by
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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Comments (116)
Great item. Thanks very much.The analyst consensus assumes that the ITC Ltd. will grow at a rate of 13.44% CAGR over the next five years.Slowness seems to have a different meaning in India.Together with the dividend yield of 2.91%, this results in a total return potential of 16.35% CAGR.Wonderful.Long $BTAFFYou don't have to increase speed or cultivate slowness, just find the right investment rhythm.
Adding dividends to growth is the usual and required way of determining the prospective investor's reward potential.But you are right that valuation is important and of course it always is.LTC Ltd is still good value based on its 5y PEGY of 1.86 and could be viewed as a moderate buy thereafter.Yes, a certain valuation risk could work to a certain disadvantage, but the appropriate valuation is always in the eye of the beholder.It clearly depends on the annualized rate at which the company will continue to grow in the future.There is no question that value investors and GARP investors and momentum investors would assess this differently in principle.I personally tend to a special variant between a risk-conscious value and GARP investing.
Nevertheless, the FDA should clearly explain their position, because it seems crystal clear that non-combustible products are far more healthy than the traditional smoked tobacco.
It’s interesting that vaping products are banned in India.
Average age 28.
They smoke at very high rates. 8-)
Menthol is popular.
So it’s under attack by nanny states.
Read California.
Now the Feds are in on it.
Quite a racist component to their reasoning too. Specifically calls out blacks, hispanics and asians.
I wonder how long it will take for those denied menthol cigarettes to start experimenting with a drop of essential oils on their cigarette filters?
With absolutely unknown consequences.
fish
Yeah, I know! The bastards confiscated my vaper while trying to board a flight back to Canada!!! WTF!!!
"British American Tobacco said in an early update for the first six months of the year that sales of cigarettes in the U.S.--its most important market--are still "disappointing." The company has lost more market share overall and its business in California has shrunk by around 25% since the state banned menthol cigarette brands earlier this year.""BAT, which still makes 83% of its revenue and the lion's share of profits in the U.S. from traditional smokes including Lucky Strike and Pall Mall. Its lower-risk smokeless products such as heated tobacco sticks and vapes are loss-making for now. BAT needs cash from cigarette sales to expand the new brands and make them profitable.""The company's big debt pile also needs to be repaid faster as interest rates rise, which means there is less cash available for share buybacks. This may explain why BAT has been the worst-performing major cigarette stock over the past five years. Improving that patchy track record depends on America's cash-strapped smokers."