ITC’s Market Capitalization Eroded by Rs 50,000 Crore in Two Days

Introduction

In recent trading days, the market capitalization (m-cap) of Fast Moving Consumer Goods (FMCG) giant ITC witnessed a significant erosion. The company’s decision to retain only a 40 percent stake in the new entity, ITC Hotels, as opposed to Street estimates of 100 percent, triggered the decline. This move came after the board of directors gave in-principle approval for the demerger of ITC’s hotel business. The stock’s value plummeted, causing a loss of over Rs 50,000 crore in m-cap over the past two days.

Approval for Demerger of Hotel Business

The ITC board’s decision to demerge its hotel business resulted in the formation of a new entity, ITC Hotels. This new company will function as a wholly-owned subsidiary of ITC. However, the unexpected announcement that ITC would retain only a 40 percent stake in the new entity was not well received by the market. The stock price dipped by 3 percent in intra-day trade to Rs 455.95, falling nearly 9 percent from its recent record high of Rs 499.60, achieved on July 24.

Market Capitalization Erosion

The impact on ITC’s m-cap was substantial, with a decrease of Rs 54,350 crore, bringing the m-cap to Rs 5.68 trillion in the intra-day deal on Tuesday. By 9:43 am, the stock quoted 2.4 percent lower at Rs 459.80, with an m-cap of Rs 5.72 trillion. In comparison, the S&P BSE Sensex was up 0.05 percent at 66,410.

Clarity Awaited from Management

ITC announced in an exchange filing that the board had approved the hotel business demerger, but more details about the arrangement would be provided during the management call scheduled for Thursday, July 27, 2023. The final approval of the scheme of arrangement is expected at the board’s next meeting on August 14, 2023.

Analysts’ Insights

According to analysts at ICICI Securities, the demerger of ITC’s capital-intensive hotel business is expected to improve return ratios and free cash flow. However, they do not anticipate any significant impact in the near term.

On the other hand, analysts at Motilal Oswal Financial Services stated that there were no substantial changes to their estimates due to the demerger of the hotel business.

Valuation of ITC’s Hotel Business

The hotel business of ITC has shown promising revenue growth over the last few years, with a revenue CAGR (Compound Annual Growth Rate) of 12.2 percent over 3 years and 12.9 percent over 5 years. The segment’s EBIT (Earnings Before Interest and Taxes) recorded CAGRs of 50.9 percent over 3 years and 31.3 percent over 5 years. Based on an 18x FY25E EV/EBITDA (Enterprise Value to Earnings Before Interest, Taxes, Depreciation, and Amortization) multiple, analysts estimate a value of Rs 16 per share for ITC’s hotel business.

Earnings Outlook for ITC

Despite the recent challenges, ITC posted a healthy ~24 percent earnings per share (EPS) growth in FY23, and the brokerage firm expects an EPS CAGR of ~15 percent over the next two years. The company’s earnings outlook appears favorable compared to other large-cap staples players for FY24 and FY25.

Valuation Re-rating and Positive Outlook

ITC has experienced a valuation re-rating, mainly attributed to its conducive setting in the cigarette business and profitable growth across other segments. Analysts at Emkay Global Financial Services maintain a positive outlook on the counter and recommend a ‘buy,’ with a SoTP-based (Sum of the Parts) target price of Rs 525 per share. They seek further clarity on the rationale behind retaining a 40 percent stake in the new entity, the royalty structure, potential tax implications, and the criteria for strategic investors, partners, or collaborations in the business.

Conclusion

The decision by ITC to retain only a 40 percent stake in the newly formed ITC Hotels entity led to a significant erosion of the company’s market capitalization. Investors expressed concerns about this unexpected move, resulting in a decline in the stock price. While analysts anticipate potential benefits from the demerger of the hotel business in the long run, further details are awaited. Despite the recent challenges, ITC’s earnings outlook remains promising, and the company’s valuation re-rating has garnered positive attention from analysts.