What is going wrong for ITC Limited? What is its main business?

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Recently, HCL Technologies, an IT major, has entered the list of top-10 most valuable companies in India recording a market capitalization of Rs 2.2 trillion surpassing cigarette major and fast-moving consumer goods (FMCG) company ITC, which has the market-cap of Rs 2.19 trillion currently.

This news makes one think about what’s not right about ITC. How is it earning its profits and what’s hampering its growth despite it being such a renowned brand?

So what is going wrong for ITC?

ITC is still a major cigarette business trying to establish an FMCG empire. They have Rs. 25,000 crores cash sitting right over their balance sheet and they just don’t know what to do about it. Its plans to diversify have not been competent enough. The company’s capital allocation strategies and policies are not pretty profitable and its share price has reflected these ambiguities.

Lesser known fact– ITC Ltd., formerly known as the Imperial Tobacco Company, has stayed true to its name all this time, being a majority player in the cigarette market for over 60 years until the 1970s when it decided to step into other segments of the Indian consumer market.  However, ITC is still the biggest player in the tobacco world and is pretty much indefatigable.

ITC’s major cigarette brands include:

  • Wills Navy Cut
  • Gold Flake Kings
  • Gold Flake Premium lights
  • Gold Flake Super Star
  • India Kings
  • Classic (Verve, Menthol, Menthol Rush, Regular, Citric Twist, Ice Burst, Mild & Ultra Mild)
  • And others – 555, Silk Cut, Capstan, Scissors, Berkeley, Bristol, Lucky Strike, Players, Flake and Duke & Royal and wave.

What is the reason behind this monopoly?

The tobacco industry is pretty restricted and regulated. One is not allowed to advertise its product or package it the way they like. The only factor needed to determine your market standard in the industry is an extremely diversified distribution network. A network that has deep roots and can access the remotest of corners in the Indian subcontinent. Such features make it nearly impossible for any other new competitor to enter into the market and fight against the well-established players.

All the above-mentioned factors give ITC the utmost advantage. It is already a well-established market player holding the most popular cigarette brands through an enormous distribution network. The company holds an experience of almost a century in this field now. Therefore, when advertising tobacco was banned, ITC enjoyed a huge advantage. The company’s dominance in the tobacco world cannot be moved very easily; one can get an idea by simply reading the related numbers. ITC holds an 84% market share in the organized sector, making it a monopoly power almost. The company has had everything on its side till now.  

So basically, ITC can never be defeated?

Not really. The only factor that can affect its business is the tax regime of the government. Cigarettes are sin products and government can heavily tax them in the name of public interest and there would be no opposition. But again, on the other side of the coin, ITC can survive that as well. Chainsmokers or compulsive smokers get habitual to the product, making the price elasticity of demand nearly 0 in their case. This means that their consumption or demand will not fall down with the rise in prices. They will be ready to pay a higher price for the same product.

But, this will also continue for a while. If you push them too far, they may have to change their consumption pattern probably by switching to some other brand or product. Just to put it out, the legal cigarette industry only accounts for 10% of the total tobacco production. So, the intolerable high prices will force them to explore the other alternatives. This is how a destructive tax regime can clearly affect the company’s market stature, especially when the cigarette segment of ITC is responsible for the company’s 80% profits all by itself.

With this data, we can conclude that the tobacco industry is more of a money minting segment for ITC. ITC made so much money with cigarettes that it supported it to diversify its operations into several forays and sectors, making it a leader in the Fast Moving Consumer Goods market as well (FMCG). ITC also stepped into the luxury hotel business in the mid-1970s.

What is the status of ITC in other sectors?

  • LUXURY HOTELS

ITC is a renowned company when it comes to high-quality hotels.  Its Hotels division (under brands including WelcomHotel) is India’s second-largest hotel chain. It has more than 90 hotels in India.

What is the difference between ITC’s hotel business and cigarette business?

  1. Unlike cigarettes, luxury hotels cater only to a particular stratum of society.
  2. The hotel business is highly seasonal.
  3. The fixed operating costs are extremely high. This means that even when the hotels lay vacant (for example during the nationwide lockdown imposed to contain the coronavirus) the business still has to bear several expenses such as salaries, furnishing costs, maintenance, licensing dee or interest expenses.

Even after all the pompous estate and show, hotel chains aren’t the real moneymakers. Running a hotel business isn’t a piece of cake. The economics is so intricate that ITC, currently, makes a return of just 3% on all the money it has invested in this business. This is known as its Return on Capital Employed (ROCE).

  • EDIBLE OIL AND FINANCIAL SERVICES

ITC has also tried its luck in edible oil. It entered in this industry with the launch of the Sundrop in 1988. It acquired Tribeni Tissues Limited in 1990. The financial services segment couldn’t perform very well and the company shelved it a couple of years ago.

  • FAST MOVING CONSUMER GOODS OR FMCG

The company entered into this segment in the mid-2000s, challenging several already established players. It was standing directly in competition with HUL and P&G in every single product vertical.

Then soon Britannia and Parle-G were in competition when ITC introduced its own line of biscuits following which instant noodles were launched by the company competing against Nestle.

Revenue from ITC’s FMCG segment jumped up from Rs. 500 crores in 2005 to Rs. 13,000 crores in 2020. However, profitability is still very debatable as this sector has only 2-3% margin while other segments have a margin of 15-20%. So, even when  ITC gets 25% of its revenue from FMCG, it accounts for only 3% in profits.

Now, the bottom line is that ITC is confusing the market players– Whether people should invest by considering its heavy cash flow from the tobacco business or take into account the not so good performance in the other sectors. This is a dilemma people are stuck in, leading to a potential future crisis. 

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