ITC shares surge, finally! Is it breaking out?

Cigarette maker ITC Ltd, which has diversified across fast-moving consumer goods (FMCG), hospitality, paper and other areas, has been one of the laggards in the stock market rally that has seen benchmark indices hit new highs. 

Despite being among the stock picks of scores of analysts, ITC had underperformed the top indices as well as its peer set. However, the counter surprised the markets with a sharp 8% rally on Thursday to touch Rs 232 a share. ITC’s stock price is now near its 52-week high of Rs 239, which it reached in February.

But the stock is still nearly 30% below its peak in 2017 when it had reached Rs 339 apiece. ITC’s share price has been sliding for the last two years in particular, much before the onset of the coronavirus pandemic that also sunk it to half its previous peak.

While most large-cap stocks in the Nifty 50 had bounced back from the lows of early 2020, when the lockdown in the country hit most businesses, ITC just about recovered. The Nifty 50 has more than doubled since March 2020 while ITC, even after today’s rally, is up just about 50% in the same period.

ITC’s counter saw a sharp spike in trading activity, with more than nine-fold jump in trading volume on the BSE and a similar spike on the NSE. A combined 136 million equity shares changed hands on the NSE and BSE till 1:49 pm. The stock had been recording a daily average of 10-20 million shares in the last few days.

Trades with heavy volumes indicate big investors are piling up on the stock, which is one of the few large caps that have been out of favour for long.

What was wrong with the ITC stock?

The country’s biggest cigarette maker and the second-largest FMCG company had been facing the ire of some institutional funds that base their investment decisions given their environmental, social and governance (ESG) norms. While ITC has a large business that is ESG-compliant, these funds tend to discount the company given its cigarettes business that still contributes a bulk of its profits.

The negative impact of cigarette consumption on people’s health has been a long-term concern and as more funds adopt ESG investment norms, ITC was losing fans.

At the same time, many fund managers perceived that the company has been slow in pushing up its FMCG business which could have given it a much higher valuation like its peers. The company’s hospitality business was also affected by the pandemic like the rest of the hotels and tourism industry.

Some have been waiting for the company to demerge its business units to spur the FMCG unit as a separate company.

Is it catching up? What do experts say?

“The stock was lagging behind in terms of performance. While several other stocks have now turned expensive, this seems to be one of cheaper stock available. The stock is now doing some catch-up, and single handedly has supported the Nifty today, contributing 30-odd points,” according to A Prabhakar, head of Research, IDBI Capital.

Deepak Jasani, head of research at HDFC Securities, believes the breakout was likely due to the expectation of restructuring of the company that could be announced next month. This is with respect to a possible demerger of one or more businesses to unlock value.

Some believe the firm is now going to enjoy better earnings profile. “We also believe elevated commodity prices would cool off in the next two to three quarters with considerable margin improvement in the FMCG business set to continue. However, investor perception of cigarettes business and its long-term prospects has been one of the biggest drags for the stock price performance in the last five years,” according to ICICI Securities.

According to B&K Securities, all of ITC’s businesses were showing favourable tailwinds in their recovery from the pandemic and a rerating is “around the corner”.

“The stock trades at an FY22E estimated dividend yield of 5.5%, higher than most fixed-income instruments today, so downside below Rs 200 is ruled out,” according to a note by the brokerage.

Chirag Shah and Nitin Gupta, analysts at CLSA, expect the company's FMCG business is on a path for a profitable scale-up and could deliver more than 26% CAGR in EBITDA over the next three years given industry tailwinds, margin levers and improving asset utilisation.