ITC’s Use of Cash

ITC has this great cash engine called Tobacco. I dug a little bit into the published 2015 results to see how ITC was using its cash.

There is good news and bad news. Bad news — Cash from Cigarettes which generated ~180%+ ROC is being used to fund FMCG and Hotels business where if the ROC is ~1% in 2015. 90% of the additional capital in ITC went into FMCG or the Hotels business. While one might argue that FMCG will make money in the long run, the hotels choice is a bizarre one as it is cyclical and a low return business. Also, they paid 500 Crores for a property in Goa that is being challenged in the courts right now. Was 2015 an anomaly on how much capital went to hotels or will this be a trend? While one might hope a more prudent allocation in the future, it is something one definitely must be concerned about. Also, a clear road to profitability on FMCG will help as well. Good News — 700 Crores out of the 1,500 Crores that were invested came from other parts of the balance sheet like deferred taxes, better TWC etc. Essentially only 900 Crores or 10% of net profit went into capital for in all FMCG and Hotels. Glass half full or half empty?

All Numbers in Crores INR
ITC Last 12 Month Net Profit 9765
Depreciation 1027
Owners Earnings Before Capex 10792
Dividends 5621
Net of Dividends 5171
Additional Capital Employed % of Capital Employed 2014-2015 ROC of Segments
Capital Employed in Cigarettes 121 8% 183%
Capital Employed in FMCG 632 40% 0.8%
Capital Employed in Hotels 769 48% 1.1%
Capital Employed in Agri -79 -5% 44.1%
Capital Employed in Papers 110 7% 17.0%
Capital Employed in Others 41 3% 32.6%
Total Capital Into Business 1594 31%
Net Capital Left After Investing in Business 3577
Additional Cash in Balance Sheet Compared to 2014 4299 Additional cash coming in from better Deferred Taxes, TWC, Cash Management etc;

Nestle and ITC


Maharastra government joined forces with a few other states banning Nestle’s Maggi creating a classic case of the government attacking a well entrenched moat Here

While it will take a while to sort this out, there is an air of uncertainty around Nestle’s flagship product in India. The biggest asset that Nestle carries on its balance sheet is its brand and this controversy puts Nestle’s most precious asset into the cross hairs. While the company has definitely the in-depth resources and financial wherewithal to survive the crisis, it still remains to be unknown as to the extent to which the moat will be breached. As warren says, ‘You only know who is swimming naked when the tide goes out’, this episode will really test the endurance and reputation of Nestle in India.¬† Even with the recent dip of 18%, the stock continues to enjoy a PE of 47, which takes the earnings yield just north of 2% making it a very expensive proposition even today.

While one might look at companies like Coca Cola which have faced such issues globally before and have emerged our relatively robust earnings power for the future here  Nestle still does not have the margin of safety required to evaluate Nestle fully. It must also be noted, there is a new breed of investors (the Buffett clones) who are watching quality companies with one-time resolvable issues to take advantage of the discrepancies that occur with these companies including Sanjay Bakshi in India (latest update on Nestle here)

Disclosure: No Position


We had written previously about ITC here.

In the recent market volatility that we have been seeing and with Maharastra (after Chandigarh) banning loose cigarettes, another stalwart in the FMCG space is fighting for the relevance of its business model and its flagship products (here). The company is trading at 25 times earnings or 4% earnings yield. With the excise duty hikes and the resilience that we have seen in the past with respect to the business model, it might be worth another look to see whether this stalwart is worthy at the current prices.

Disclosure: Long ITC