Brokerages are recommending a buy on ITC, whose share price rose over 3% on Thursday after the broader market lost over 2.6%. Strong results for the fourth quarter and fiscal year 2021-22 are a near-term trigger. But strong results for segments such as cigarettes and paper and paper products indicate that the pandemic is behind us, and that the market now sees the pandemic in the rear-view mirror as well.
The pandemic had taken a toll on cigarette sales, with the lockdown curtailing mobility and cigarette sales and the direct impact of COVID-19 on the lungs and respiratory tract, highlighting the excitement of pouring cold water. The latest results show that cigarette sales have exceeded pre-pandemic levels. The segment’s revenue grew by 10% and earnings before interest and tax by 12%.
ITC’s newfound support with investors and brokerages cannot be attributed to strong corporate performance alone. The company has been undervalued for some time. While there are no diversified tobacco majors for a fair comparison, it would be useful to compare ITC with a sterling fast-moving consumer goods company such as Hindustan Unilever (HUL) (while cigarettes remain a cash cow for ITC, the company’s recent non-cigarette Divisions such as FMCG, Hotels, Stationery, Paper and Paper products have increased investment and manpower).
The share price to earnings per share (P/E) ratio for ITC is 22.56; For HUL it is 60.31. The price-to-book ratio (share price as a multiple of book value per share, i.e. when the company’s book value is distributed over its outstanding shares) is 10.91 for HUL, less than half that for ITC. Also, ITC has a better return on net assets as measured by ROE (return on equity – equity is what remains after subtracting debt from a company’s total assets). The ROE for HUL is 18% and for ITC is 22%.
Is there any valid reason for such a huge gap between the price-earning multiples for ITC and HUL? When liquidity is as abundant as it is during pandemic-era huge wealth creation, investors can afford to be guided by factors that primarily drive stock prices rather than corporate fundamentals . Only fundamentalist fanatics like Warren Buffett, with his philosophy of value investing, focus on building corporate value during bull runs.
In addition to a company’s ability to conduct efficient business and generate returns for investors, several factors drive stock prices up and down. Being part of a segment expected to perform very well can be one. In the tech boom at the turn of the century, many companies changed their names to acquire a technical aura, and saw their share prices rise as tech-hungry investors poured money into any technology. Environmental, social and governance (ESG) factors are another factor. In a rising market, funds join their ESG championships, investing their money in stocks of companies that are considered strong on ESG factors and withholding funds from ESG-negative companies.
Precisely because ITC has to contend with its strong negatives on social factors, thanks to its tobacco division, it is more environmentally friendly and sustainable than most peers. “The company exceeded commitment on plastic neutrality; collected and sustainably managed over 54,000 tonnes of plastic waste. ITC retains its ‘AA’ rating by MSCI-ESG – the highest among global tobacco companies The company is also included in the Dow Jones Sustainability Emerging Markets Index and is rated by the CDP on a ‘Leadership Level’ score of ‘A-‘ for both climate change and water security,” ITC declared in its results press statement. does. and its current boss, Sanjeev Puri, heads the Confederation of Indian Industry’s sustainability initiatives. Still, the fact that ITC’s tobacco business lies with investors. This could be a reason for the poor performance of its stock in comparison to pure-play FMCG companies.
When stock prices are no longer a sea of easy money to swim on, as is now happening with the tightening of monetary policy around the world, corporate performance matters more. BlackRock, the world’s largest asset manager with more than $10 trillion under its belt, used to be a huge champion of ESG. Now that the market is tanking and oil giants like ESG-Untouchables are making obscene profits, in the wake of the recent spike in energy prices, BlackRock has announced that the financial best interests of its clients outnumber ESG.
ITC has paid some 48,000 crore as dividend in the last four years. Its non-tobacco business continues to grow strongly, even as tobacco continues to deliver reliable profits. The relatively low priced, dividend paying ITC becomes an attractive bet. The sheen that stocks have gained in the wake of the cessation of global excess liquidity is another sign that the market believes the pandemic is behind us.