Approaching BAT in Market Value: What's Happening in Indian Tobacco Giant ITC Ltd

According to a report by Moneycontrol, Indian tobacco giant ITC Ltd is catching up to British American Tobacco in terms of market value. Currently, ITC Ltd has a market value of $64 billion, just slightly below British American Tobacco's $68 billion.

British American Tobacco (BAT) recently sold its stake in ITC worth approximately 170 billion Indian rupees (2 billion USD). BAT's stock has dropped 21% in the past year, while ITC's stock has increased by around 11%.

Why is the market value of Indian tobacco rising so significantly? And how did two companies with intersecting links in capital reach the impending "turnaround" today?

2FIRSTS conducted an inventory and analysis of recent market trends and capital changes in the Indian tobacco industry.

Diversified Business

The headquarters of ITC are located in Kolkata, and approximately 75% of its pre-tax profits come from cigarettes. It is India's largest cigarette manufacturer, with three out of every four legally sold cigarettes produced by ITC.

As a diversified conglomerate, ITC has recently become India's largest fast-moving consumer goods (FMCG) producer and operates the country's second-largest hotel chain. It is also India's largest private agricultural enterprise and operates the country's largest paper industry.

In 2023, the board of directors approved the split of ITC's hotel business. CEO of British American Tobacco (BAT), Tadeu Marroco, remarked that ITC's stock price is undervalued compared to other consumer goods competitors. The separation of the hotel business will provide greater flexibility for future capital allocation.

ITC is a company that has consistently performed exceptionally well. In terms of financial performance, it has added value compared to BAT, with its stock performing very strongly in recent years. It remains undervalued compared to most fast-moving consumer goods companies in India.... Therefore, there is still plenty of opportunity for further growth in ITC's stock price. We believe that ITC has a long way to go in terms of future stock performance and value creation.

ITC and BAT: Tangled Web of Capital Connections 

Despite their optimism, BAT withdrew their investment in ITC in 2023.

British American Tobacco (BAT) initially invested in ITC in the early 1900s. Prior to the recent sale, BAT held approximately 29% of the shares in ITC, making it the largest shareholder. BAT also had two representatives on the board of directors at ITC, and frequently provided input and raised questions regarding the company's operations.

In December 2023, during the annual earnings update conference call for BAT, CEO Marroco told analysts that BAT does not need to hold more than 25% of the shares in ITC to have strategic influence and veto power. Therefore, they are considering divesting. Marroco also mentioned two major challenges to divesting from ITC. The first is India's foreign direct investment rules for the tobacco industry, particularly the "prohibition of international companies investing in the Indian tobacco industry." Any actions taken by BAT regarding their shares require specific approval from the Reserve Bank of India, which Marroco believes "greatly increases bureaucracy and operating costs." Therefore, BAT has made the decision to sell their shares.

New Market: High-end Nicotine and Novel Derivatives

ITC Corporation's recent strong momentum largely stems from its continuous innovation. In the past five years, the number of new products launched by ITC has increased by over five times, accounting for nearly 17% of total sales. Furthermore, its management announced at the end of 2023 that the company will venture into another potential market worth $500 million: the export market for premium nicotine and its derivative products.

During the investor conference held in December 2023, the management of ITC explicitly stated in discussions with analysts that nicotine has been identified as one of the new growth drivers for the diversified agriculture enterprise.

Due to the increasing global demand for premium nicotine products, the profit margins are high. This is because the processing of such products is quite complex, leading to a high entry barrier. Additionally, Indian tobacco is known for its high nicotine content, giving it promising growth prospects.

The advantage of ITC lies in its powerful procurement capabilities, which enable it to achieve a seamless supply chain from farm to cigarette packet. The result of streamlining the supply chain is the ability to provide complete traceability, which solves a major pain point in the still "wildly growing" new tobacco market.

ITC expects to see growth in new nicotine products such as flavored capsules under stable tax policies. However, due to a high base, recent growth may level off. Cigarette sales for ITC (fiscal year 2024) are expected to return to the levels seen in fiscal year 2013 (with a projected annual compound growth rate of around 3.75% for fiscal years 2019-24). ITC management has stated that the export of food technology and nicotine derivatives will create significant value for shareholders in the coming years.

2FIRSTS will continue to track developments of tobacco companies in India.