ITC – The (one) optimistic side of the SUUTI Stake Sale

Yesterday, there were contradictory media reports on the Indian government looking to sell its c8% stake held in ITC, via SUUTI, which led to a further decline in the stock.

ITC has confounded many investors/ analysts, and a larger part of the buy side/ sell-side analysts have gone wrong on the stock for the largest part of the last five years. I myself have been wrong in bits and pieces, most recently just ahead of the COVID-19 inspired selloff, when the stock was trading at around Rs 210-220 levels.

The weak performance of ITC stock over the past few years is in sharp contrast to large cap consumer staples, to which ITC was compared without hesitation until very recently (1-2 years ago) by most analysts in India. While HUL/ Nestle India stock prices have compounded at c20% CAGR over the past five years, and Dabur and Marico have compounded at c10% CAGR, ITC has returned minus 6% CAGR. Discussion on ITC with sceptics nowadays usually starts with a dismissive “It’s a cigarette company; government doesn’t like cigarettes”; some blame inefficient capital allocation by the company, and point unapprovingly at diversifications done by the company decades ago. By and large, most people believe the company must have done something wrong and that is why the stock has been such an underperformer.

Fewer people would have gone wrong predicting the stock, if this were true.

Fact is, that the stock has generally declined/ underperformed peers despite earnings growth that is, more or less, comparable with (consumer staples) peers. The following table provides five year and three-year earnings CAGR for ITC versus large FMCG peers, and notes the changes in the valuation multiples between May 2015 and now:

Table 1: Earnings Growth and Valuation Multiples, Large Consumer Staple Cos

	PAT Growth, 5 yr CAGR	Price, 5 yr CAGR	PER TTM (Now)	PER TTM (May, 2015) *
ITC	9%	-6%	13	27
HUL	12%	18%	66	49
Nestle India**	11%	21%	86	55
Britannia	14%	21%	54	41
Dabur	8%	12%	55	44
Marico	13%	9%	38	46
Average, ex- ITC	11%	16%	60	47
*Calculated as price on 5 May, 2015 divided by FY2015 earnings
** Dec end FY, earnings approx to closest year for comparison

ITC stock’s weak performance is almost ENTIRELY attributable to a continual de-rating of the stock. For underperforming peers’ average earnings growth by approximately 2%, is it justified that ITC should be de-rated from 27X to 13X, while the average of the remaining should be re-rated from c45X to 60X?

In my opinion, prices have fallen largely on one factor – supply of the ITC stock, by categories of shareholders indifferent to earnings delivery, and having little interest in whether one stock offers more value than the other. There have been two sources of supply of the stock, over the past five years or so: 1/ ESG (Environmental, Social, and Governance) motivated ETFs (foreign portfolio investors), and 2/ the govt, via its stake in SUUTI, which has been a constant overhang on the ITC stock– as soon as the stock performs, one knows, the government will be happy to dump the stock in the market.

ITC is a story of de-rating, almost irrespective of earnings delivery. In the case of most other peers, about 60-65% stake is held by the promoter, while in the case of ITC, two of the largest bunch of shareholders want to significantly reduce stake. That, in a large part explains the divergence between what has happened to ITC versus peers over the past few years. ITC has become yet another example of how “the float is as important as the moat”, even over a reasonably long timeframe.

Let’s see what has happened to the shareholding in the stock, over the past few quarters:

FPIs have continually sold down ITC stock, likely on ESG concerns. Over the last 16 quarters, FPIs have sold 6.2% in ITC, SUUTI stake sale has reduced by approximately 3%, and MFs have bought about 7.3%.

Table: ITC’s institutional shareholding

MM-YYYY	FPI	Mutual Funds	Insurance Cos	FIs/ Banks
03-2020	14.7	9.9	21.7	8.0
12-2019	15.2	9.6	21.7	8.1
09-2019	15.6	9.5	21.7	8.1
06-2019	16.8	8.6	21.7	8.1
03-2019	17.0	8.5	21.5	8.1
12-2018	17.1	8.3	21.7	8.1
09-2018	17.3	7.9	21.8	8.1
06-2018	17.5	7.5	22.1	8.1
03-2018	18.0	6.3	22.2	8.6
12-2017	18.6	5.6	22.5	8.6
09-2017	19.1	4.7	22.5	9.2
06-2017	20.0	4.2	22.5	9.2
03-2017	20.1	4.0	22.6	9.2
12-2016	20.3	3.1	21.1	11.2
09-2016	20.9	2.7	21.2	11.2
06-2016	20.6	2.5	21.3	11.3
03-2016	20.5	2.7	21.3	11.3

Source: BSE

The stock has, in my opinion, failed to hold on to a reasonable valuation relative to peers, because, on a day-to-day basis (not only have FPIs sold, they have sold in every single quarter), there has been FPI selling (mostly, we presume, ESG motivated) in the stock – ESG motivated FPIs have likely used every rise to sell into the stock. In addition, the government’s weak finances and the significant SUUTI stake, which has been offloaded from time to time, have been a continuous overhang on the stock. The consistent buying from MFs is proof that they believe in the stock; that they haven’t bought even more aggressively is perhaps attributable to the fact that no fund manager wants to take a chance against the FPI and SUUTI guerilla size holdings. They have been kind enough to value, but they don’t want to chance their career with it.

ITC stock has thus lost its mojo. Once it becomes common knowledge that every significant rise in the stock will be sold into, the strength of the bid continually declines. The largest seller of the stock is waiting for a higher price to sell into, and the largest buyer knows that. The stock has stopped celebrating even good news, and only mourns bad news. Sometime ago, it stopped celebrating when additional taxes weren’t levied in GST meets; it showed no signs of life when the ban on cigarettes was lifted three days ago. I don’t know how others view this, but if there is one thing I dislike about a stock I own, it is a lack of enthusiasm in price over what is positive news. The stock has lost predictability, even as earnings have been predictable by and large.

With this context, consider the decline in the ITC stock in the most recent round, including today: it seems reasonable to assume that the ESG motivated sellers should now (in March-May) have exited almost to the full extent desired (considering the market state, and that ITC would likely have been the first on the selling radar of such investors); with the SUUTI stake sale, the overhang on ITC stock will be finally over, although at a significant initial cost (the price shall initially fall on such massive supply). The SUUTI stake sale shall likely be the last act in this long and unhappy marriage of ITC and its significant shareholders. And I, for that reason, am looking forward to it.

I would rather take an initial loss on my current holdings and have a more predictable stock from then and onward.

Disclaimer: None of the above implies a recommendation. I/ my clients may be invested in the stock, and what is written here may have nothing to do with actions that I may take on the same going forward. Facts presented have been verified, however, the same may contain human errors/ errors from database. Therefore, this article shall not be responsible for any investment decisions that you may take based on the facts as presented.