I was surprised they didn’t sue Dr. Ashwath Damodaran when he
opined that ITCs bestdays are behind it.

We have all had crushes during our school
days and almost always our crush would just create a flutter, never materialise
into anything meaningful, we would try and attract the person’s attention,
protect them fiercely (without the same mattering to the subject), it would
always remain a sweet memory, would eventually fade into oblivion without
giving any carnal or emotional happiness but You won’t ever hear anything
against it.

Well that’s the story of ITC’s
shareholders and how this amazing company with an infinite potential will
eventually take an entire generation of dividend lovers down with it and would
become a case study just like The General Electric.

History is replete with examples of
companies that got consumed by hubris because they had no real owner, no one
was answerable, shareholders had no say, the management had no skin in the game
and the board was only self-serving to ensure that their own compensation was
secure – to hell with shareholders.

Now a few of You while reading this
would be euphoric about this momentary surge in the share price over the last
few months and the celebrated dividend yield. Little realising that when
shareholder’s equity/capital is invested, the purpose of the same is to
consistently enhance return on equity at an attractive IRR, but not set the foundation
for permanent capital destruction.

General Electric, Enron, Indiabulls,
…. (the list is infinite) are just a few examples where dividend yield kept the
hopes of the romantics (shareholders) alive while consistently destroying
shareholder’s wealth.

There are more than many companies
that provide adequate capital protection, better corporate governance, great
dividend yield and ‘far far’ better capital allocation strategies – but that’s
for another day.

For the longest period of time GE was
the most respected company, Jack Welch the most celebrated leader (the folklore
goes that his Salmon for lunch would fly in from Norway in Company’s private
jet – obviously at the shareholder’s expense), could do no wrong. His word was
the gospel truth in management and leadership, people loved the dividend yield
and yet he set the stage for its eventual demise. This got discovered much
after he was gone.

And while there were so many instances
of 30-40% surge in its share-price since 1990, GE eventually reached where it
was destined to – NOWHERE.

And anyone thinking that ITC will create any shareholder wealth, will have an
ever-increasing ROCE, will be disappointed and this piece will go down in
history as the most momentous piece. For no amount of defamation suit can
possibly muffle the logic or the sound reason behind a compelling argument. And
the liberty provided to me by my constitution u/s 19 is
obliged to fiercely protect this right.

I was amused when ITC gave a 10 hr investor
presentation last year. Companies that cant face shareholders, give 10 hr long “one-sided”
presentations that can barely pass the muster of being more than a new
employee orientation presentation, one-way communication trying to justify the
underperformance in the garb of future potential.

Most Promoters would resonate with what
I am talking about – when employees hoodwink boards and shareholders by their
specious Annual Operating Plans by presenting a 10 year vision and a large part
of that vision would reach fruition only towards the later part of that plan.
As someone clichédly said “more fiction is written on PPT’s and Excel Sheets
than by Rowling or Dan Brown”.

I actually have very vivid memories of
a sales professional who worked for me (not too long ago), who would always
promise a brighter future just a few years down the line. I had the luxury of
knowing that person for 8-9 years so would always end up musing about the
missing results of the actions that were taken 9 yrs ago that were to fructify
into profits/performance 6 years ago – the saga went on and on. But yes,
companies and professionals on their eventual irreversible decline almost
always say that the worst is behind us, all is sorted, future is bright and
everything will fall into place just a few months before the superannuation.

Readers of this piece who invest in the
markets and have reasonably good memory can well relate to “the worst is behind
us” narrative peddled by a PSU bank and an automobile company. Unfortunately, for
years and years this narrative alone has been enough to mislead the
shareholders. (This for another time and another piece).

But let this all not just be a
narrative. Let’s get to the numbers and the real performance because numbers
don’t lie.

For the longest period of time ITC has
been peddling false narratives about their capital allocation (masked
destruction) and a faraway lala utopian land. Most of my argument
against their questionable narrative perpetrated over time has been called out
in my 2 earlier pieces

10
Blunders – One arrogant company ( Millions of Shareholders Suffering ) – The
story of ITC

And

Magic
Illusion or Just trickery – The story of ITC

But really as a minority shareholder i
can see and strongly opine, if ITC was to just sell out their entire gamut of
FMCG and Hospitality businesses to either Nestle, Britannia, Adani or Unilever
and hotels to IHCL or Oberois (Under the blessings of Reliance) they can
probably save the company – but the self-serving board of  ITC would technically become redundant if they
actually put the company on the path of propriety … Simple.

The chart below is a glaring evidence
of abysmally low return ratios in the hospitality business and the FMCG
business. One wonders, had the cigarettes not been subsidising everything else,
the managers would have successfully bankrupted these 2 divisions long ago. To
be fair to the line managers including the CEO’s of the divisions, they are
nice guys – professional – but completely out of control because they can’t
handle the burden of their division’ legacy and bloated balance sheets.

Most of the alleged growth is coming
from Agri Business over the last few years – at ever depleting margins. For the
record the Agri business operated at an abysmally low EBIT of 5.5% in H1 FY 23,
6.6% in FY22 vs 7.1% in FY21 – Margins are consistently shrinking when the
entire corporate world had the best of the last 2 years. This is a reflection
of poor managerial governance.

Agri Business (as per H1 FY 23 B/S) is
~Rs. 6,000 Crs in assets. Assuming it is a depreciated value at 12% per year
for last 10 years, the real capex made is ~Rs. 22,000 Crs. [ 6,000/(1-r%)^n)].
Assuming this capex was done equally over last 10 years, at an IRR of 13%, this
would have been ~Rs.40,000 Crs worth of equity, but currently it is only
generating Rs. 1,200 Crs of annual EBIT at 3.0% efficiency whilst the GOI bonds
are generating upwards of 7%. It doesn’t take an expert to figure out what this
means and what these numbers are hiding.

Taking credit for increase in cigarette
sales.

Can a well-meaning manager at ITC take
credit for more people converting into smokers or a smoker, smoking more
cigarettes than ever before. And if cigarettes sales are increasing thereby
increasing profits – it’s just plain luck for that division’s P&L and
Balance Sheet.

ITC is doing exceedingly well and
turning around while generating a handsome dividend yield.

This argument is pushed more than
often by all analysts and Fund Managers in media.

The other side of the same argument very
convincingly sounds –

ITC has lost the plot because after
investing Rs. 1,77,000 Cr of shareholder wealth and putting it in jeopardy,  (Numbers and arguments in the later part of
this article), ITC is still at the bottom of the stack in all operational metrics.

CHARTS

Top FMCG companies when compared with
ITC

ITC’s EBIT Margins continuously lag
due to highly commoditized products (Atta), subdued margin profile as other
product lines are category challengers (Biscuits, Noodles, Cosmetics etc.). Koi
puche inse – bhai muddat ho chali hai – kar kyaa rahe ho jo itna boora haal
hai.

Top listed Hotel companies compared
with ITC Hotels.

EBIT and EBIT Margins continue to lag
when compared with the peers, for e.g. in FY21 and FY 22, it has the highest
EBIT loss and EBIT Margin is negative, implying higher fixed cost structure and
lower operating leverage. Also, even after the industry’s pent-up demand since Feb’22,
the EBIT Margins still reek of inefficiencies.

The only solution to all this is a
cluster of some serious, young, experienced and well educated outside
professionals on the board that put a stop to the empire building and stop the
equity haemorrhage thereby protecting shareholder’s interest.

Personal empire building must stop and
the adage “Our Ex Chairman liked hotels” must be replaced by a cutting edge
uncompromisable quest for Return on Equity. Division heads should be clearly
told to operate and expand without dipping in papa’s pockets. That’s when ITC
and its downstream divisions will come off age.

But then the party must stop for
inefficient managers. Is ITC ready for that? In my opinion it never will be –
till they reach a stage where they don’t have sufficient cash to pay liberal
dividends and dividend yields start to plummet.

Disrespect For Free Cash

Take for example the acquisition of
Mylo (a company involved in digital marketing?) at a valuation of 400 Cr. A
company that presently does Rs. 3.4 Crs in sales with a PAT of Rs. (minus) -15.9
Crs has been valued at 400 Cr. And ITC wasted 40 Cr of shareholder wealth for 10%
of equity in this company for what? Could India’s best digital marketing company
not be given a professional contract for the same value add with quantifiable
deliverables? Is Mylo giving any service for free to ITC? My only recollection
of Mylo is Jim Carrey’s puppy in ‘The Mask’.

Delve deep through discovery of data and
I would not be surprised if some vested interests are at play.

Hotels

Hotel Assets (as per H1 FY 23 B/S) are Rs. 7,500 Crs. Assuming it
is a depreciated value at 12% per year (blended for the purpose of brevity) for
last 10 years, the real capex made is ~Rs. 27,000 Crs  [7,500/(1-r%)^n)]. Assuming this capex was
done equally over last 10 years, at an IRR of 13%, this would have been worth
~Rs. 50,000 Crs of Shareholder’s Funds, but currently this investment is only
generating Rs. 227 Crs of TTM EBIT. Which incidentally includes all the
revenues from all the expansion and chest thumping management contracts that are
being signed to masquerade itself to be a fast-expanding hospitality brand.

FMCG Division

Assets (as
per H1 FY 23 B/S) is Rs. 13,000 Crs. Again, assuming it is a depreciated value
at 12% per year for last 10 years, the real capex done is of ~Rs. 47,000 Crs
[13,500/(1-r%)^n)]. Assuming this capex was done equally over last 10 years, at
an IRR of 13%, this would have been ~Rs. 87,000 Crs worth but currently it is
only generating Rs. 1,000 Crs of annual EBIT.

Destroyed Capital

If this Rs. 1,77,000 Crs (approx. 21.5 Billion USD)  (Agri : Rs. 40,000 Crs + Hotels Rs. 50,000 Crs
+ FMCG Rs. 87,000 Crs) was simply put in govt of India bonds with annualized 7.5%
per annum, the same would fetch ~Rs. 13,275 Crs viz a viz the present cumulative
~Rs. 2,475 Crs per annum with underlying capital/capex permanently destroyed
unless monetised at a later stage.

The only viable solution out of this persistent and incurable
inefficiency is to respectably monetise its hospitality division and sell it to
either IHCL (a far more efficient organisation) or to Oberois that really know
how to efficiently manage hotels, create cutting edge globally recognised brands
and are on a sustainable expansion spree. I believe even Lemon Tree would do a
better job.

And Unilever / Nestle would be happy,
in the interest of scale, to acquire, and probably pay a respectable premium
for the FMCG division of ITC. But above all there would be no better suitor
than Adani Wilmar or Reliance Retail for which ITC-FMCG will provide a much-needed
backward integration (largest retail chain), efficient operations and a respectable
exit / face saving for ITC.

Here is another prediction 

The
Board of ITC will never ever demerge its divisions because that will put an end
to the party that has been going on as division heads will have to become self-sufficient,
raise capital, manage debt and above all answer to shareholders when industry
benchmarks of performance aren’t met.

History will be unkind to BAT, LIC and
SUUTI with combined ownership of 52.66% (BAT : 29.22% LIC: 15.57% and SUUTI :
7.87% respectively) which continue to see a gradual haemorrhage of the
intrinsic value of this company that has amazing potential and an opportunity
to resurrect itself from the path of permanent destruction.

If ITC doesn’t get its act together,
doesn’t stop muffling the voice of reason and logic, continues to waste its
cash on lawsuits, the day isn’t far when the dividend yield might still remain
an attractive 5%, but the share price is much much lower and expense on
defamation suits would be a significant line item in its expense statement.

Price vs Reality

Dr Ashwath Damodaran, popularly known
as the God of Valuation, was hailed when Zomato exactly touched the price that
Dr. Damodaran put as its fair value. And according to his metric as per the valuation
lecture of July’2019 valued ITC at Rs. 170

(https://pages.stern.nyu.edu/~adamodar/pdfiles/country/val2dayIndia2019.pdf). Using
the same methodology, we arrive at a price of Rs. 206 as below.

Sum of the Parts Valuation as on date :

The cottage industry of the ITC memes might not be dead yet and the thunder of these memes’ last laugh might yet be heard.