ITC shares have delivered negative returns over the last three years, largely due to investors anticipating that the company’s tobacco business earnings will remain low, while the valuation of its non-tobacco business appears stretched relative to its peers.
According to BSE data, ITC shares are 37% down over the last three years compared to a 15% gain in the equity benchmark Sensex. Over the last year, the stock has lost 37%, while the Sensex has shed 6%.
In a report on 3 September, Kotak Institutional Equities (Kotak Securities) highlighted that its reverse-SoTP valuation of ITC shows that the company’s tobacco business is available at around 11 times one-year forward EPS (FY27-28E EPS). This suggests that the market expects the tobacco business’s earnings to stagnate at ‘low’ levels. The market also appears to believe that the value of the non-tobacco business is much lower. To some extent, it also shows that the market has strong apathy toward the tobacco business.
Kotak, whose 12-month SoTP valuation of ITC is ₹360, estimates ITC’s tobacco segment EBIT to be flat over FY26-29E and non-tobacco FMCG segment EBIT to grow at 19% CAGR over FY26-29E.
“We use 16 times September 2028E EPS to arrive at a 12-month fair value of ₹194 for the tobacco businesses and 30 times September 2028E EBITDA of the non-tobacco business to arrive at a 12-month fair value of ₹80 on a non-tobacco basis. We ascribe ₹84 to the other businesses and cash,” said Kotak Institutional Equities in its report.
Market expects ITC’s tobacco business earnings to decline?
According to Kotak, its 16 times two-year forward P/E multiple for ITC’s tobacco business appears “reasonable, as it implies 4.8% growth in FCFE in perpetuity, assuming 11% cost of equity and 5.8% growth in FCFE in perpetuity, assuming 12% cost of equity.”
“We would note that the implied growth in net profits is similar to PAT growth estimates for the major global tobacco companies. The implied P/E of 11 times for the tobacco business in our abovementioned reverse-SoTP exercise would suggest that the market expects earnings of the tobacco business to stagnate in perpetuity at low levels and views near-term earnings of the tobacco business as too aggressive,” Kotak said.
Is the non-tobacco business multiple high?
Kotak argues that its 30 times two-year forward EV/EBITDA for ITC’s non-tobacco business could appear high compared to its peers following the sharp derating in their multiples in the last few months.
However, Kotak expects profits from ITC’s non-tobacco business to grow faster than those of other companies. This could be because of stronger growth relative to peers, given lower market shares in several key categories, and the scope for margin expansion as the business scales up.
“We see strong growth in revenues and EBIT despite moderate expansion in EBIT margin of the non-tobacco business in the next few years,” said Kotak.
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