The ITC stock may have slipped out of the market spotlight, but Kotak Institutional Equities believes the current valuation raises a bigger question – is the market assigning too little value to the company’s tobacco business and its other operations?
According to the brokerage report, its reverse sum-of-the-parts (SoTP) exercise suggests ITC’s tobacco business is being valued at only around 11 times one-year forward earnings. Kotak believes this leaves little room for the market to recognise any meaningful earnings growth.
Let’s take a look at what the Kotak report says –
Kotak’s assessment points to a sharp disconnect between the business and its implied valuation.
The brokerage said, “Our reverse-SoTP valuation exercise of ITC shows that the tobacco business of ITC is available at around 11X 1-year forward EPS.”
This means that the valuation suggests investors are expecting very little from the tobacco business over the long term. Kotak believes the market could be assuming that earnings will remain weak or stagnate.
The brokerage added, “This would suggest that the market (1) expects the earnings of the tobacco business to stagnate at ‘low’ levels in perpetuity, (2) believes that the value of non-tobacco business is much lower and/or (3) has large apathy for the tobacco business.”
Does the business outlook justify such a low valuation?
Kotak does not think so. It uses a 16 times September 2028 estimated earnings multiple for the tobacco business, arriving at a fair value of Rs 19 for that segment.
The other side of ITC is valued quite differently. Kotak uses a 30 times September 2028 estimated EBITDA multiple for the non-tobacco business and arrives at a fair value of Rs 80.
At first glance, that multiple may look expensive compared with some peers. Yet Kotak argues that ITC’s non-tobacco businesses could grow faster because the company still has relatively low market shares in several categories.
The brokerage said, “However, we expect profits of ITC’s non-tobacco business to grow faster versus other companies.”
It also sees room for margins to improve as these businesses become larger.
The brokerage believes ITC could potentially benefit from separating its tobacco operations from its non-tobacco businesses.
This is because the two businesses attract different kinds of investors.
Kotak believes the tobacco entity could appeal to investors looking for steady earnings and dividends. The non-tobacco company, meanwhile, could attract investors focused more on growth.
The brokerage said, “We believe that a vertical split of ITC into two different entities with (1) the tobacco business in one entity and (2) non-tobacco businesses in another entity could unlock significant value for shareholders.”
It further explained, “The tobacco entity will likely attract ‘value’ shareholders looking for steady growth and high dividend yields while the non-tobacco entity will attract ‘growth’ investors.”
Kotak’s analysis suggests that the current market price may not fully reflect the potential value of ITC’s different businesses.
The brokerage also noted that its 16 times forward price-to-earnings assumption for tobacco is reasonable, as it implies modest long-term free cash flow growth rather than an aggressive outlook.
ITC’s market outlook depends on whether investors continue to value the company as one large diversified business or begin assigning separate values to tobacco and non-tobacco operations.