Smokers, just like the drinkers, had a very hard time during the lockdown period. They had to look out for the places where the cheapest packs of cigarettes could be found in the black market. The cigarette companies had stopped production and the regular pan shop and bakery were closed. Every grocery shop owner had put in their savings to pick extra stocks of cigarette. It was a horrid time for the smokers as the average price in the black market was anywhere between 33 per cent and 100 per cent above the MRP.
This is an analysis of the top three cigarette makers who control most of the legal cigarette market. Tobacco is consumed in many forms in India. Most of the smokers take it in the form of Bidi (one packet of which is cheaper than one stick if the cheapest cigarette). Cigarette is among the highest taxed commodities in India. Whenever the government anticipates a shortfall in revenue collection, it always looks towards the cigarette companies and slaps additional taxes. Cigarette industry also has to deal with illicit cigarettes in a big way. India is the fourth largest market for illegal cigarettes. Duty paid cigarette consumption is just 10% of the total tobacco consumption in India, but it contributes to 88% of revenue generated by the Govt. of India from the tobacco industry. One estimate says that the total revenue loss for the government due to illegal cigarettes is more than Rs. 13,000 crore per annum. Duty paid tobacco industry employs lakhs of people (including farmers) directly and indirectly. Cigarette as an industry survives in India in spite of high taxes because of the elasticity in price it offers. But this elasticity has a limit.
Our three companies are ITC, Godfrey Phillips and VST Industries.
ITC Limited
ITC is mainly into the cigarette business and it has also forayed into other businesses. Almost 80% of ITC's profit comes from the cigarette segment. ITC is also into hotels, agri business, staple, packaged food, personal care products, agarbatti (incense stick), match stick, chocolate, spices, stationary, Information Technology, and paper board & packaging. The company has many of the businesses which are aligned to its cigarette business. The company is led by Mr. Sanjiv Puri who is the Chairman & Managing Director. The company has the target of earning revenue of Rs. 1 trillion through FMCG segment alone by the year 2030. ITC's other businesses operate at very low margin and they will definitely require a few more years for them to be impactful in terms of profit.
Cigarette brands offered by ITC
Insignia
India Kings
Classic
Gold Flake
American Club
Navy Cut
Players
Scissors
Capstan
Berkeley
Bristol
Flake
Silk Cut
Duke & Royal
ITC's FMCG brands
Source: ITC Portal
ITC owns a few of the best known hotels in India. The hotels are offered under 'The Luxury Collection' (a Marriott brand), 'Welcome Hotels', 'Fortune Hotels', and 'Welcome Heritage'. The company had started its hotel business in 1975 and it has made a mark for itself based on high quality of service it provides. The business is profitable and the company has been trying to add new properties to its portfolio regularly.
Source: ITC Hotels Website
ITC also has an Information Technology subsidiary which is yet to take off in a big way.
Godfrey Phillips
The company is a flagship company of the $2.8 billion Modi Enterprises which also owns Indofil Industries. Godfrey Phillips is a name to recon with because of the brands it offers. The company is led by a team consisting of Dr. Bina Modi, Samir Modi, Sharad Aggarwal and Bhisham Wadhera (CEO). The cigarette brands offered by the company are:
- Four Square
- Red and White
- Cavanders
- Tipper
- North Pole
- Stellar
The company manufactures and distributes Marlboro brand of cigarettes in India under license from Philip Morris International.
The company also offers chewing products under the Pan Vilas, Pan Vilas Super Dewz and Raag brands. The confectionary products are offered under Pan Vilas and Fundaa brands.
Godfrey Phillips has successfully forayed into the retail sector through its 24Seven stores. The stores see an average footfall of 2000 customers every day per store. The company's retail brand has over 100 stores across Delhi, UP, Haryana, Chandigarh and Punjab.
Godfrey Phillips' 24Seven Stores
VST Industries
History of VST Industries dates back to pre independence India. The company had started out as Vazir Sultan Tobacco Company and transformed itself into a professionally run cigarette maker. The website of the company is unsecured and it is not a place from where an investor can gather much information about the company.
The cigarette brands offered by the company are:
- Charms
- Charminar
- Total
- Editions
- Gold
- Moments
The company manufactures and distributes Benson & Hedges and Dunhill brands of cigarettes (brands owned by Rothmans) in India.
Shareholders of ITC, Godfrey Phillips and VST Industries
ITC has no promoter holding. As of March 31, 2020, LIC owned 16.27% shares of the company. Public sector insurance companies own more than 20% shares of the company. SUUTI (a Govt. of India organization) owns 7.94% of shares. Tobacco Manufacturers (India) Limited, Myddleton Investment Company Limited and Rothmans International Enterprises Limited owned 24.26%, 3.96% and 1.26% of shares respectively. Mutual Funds owned 9.94% as of 31 March 2020.
Promoters hold 72.19 per cent shares in the company. Dr. Bina Modi holds most of the promoter shares through many KK Modi & Bina Modi trusts and Good Investment (India) Limited. Philip Morris Global Brands Inc holds 25.10% shares of the company. Avinash Vazirani managed Jupiter India Fund owns 7.29% and Jupiter South Asia Investment Company Limited - South Asia Access Fund owns another 1.40% shares. Individual share holders own 11.56 per cent shares.
VST Industries has 32.16 per cent promoter shareholding. The promoters are The Raleigh Investment Company Limited (23.45%), Rothmans International Enterprises Limited (0.43%) and Tobacco Manufacturers (India) Limited (8.28%). Mutual Funds held 13.81 per cent shares and FPIs held 5.47 per cent outstanding shares. Radhakishan Shivkishan Damani held 4.97 per cent shares directly and 25.95 per cent shares through his company Bright Star Investments Private Limited.
The Raleigh Investment Company Limited which is a promoter of VST Industries is related to Myddleton Investment Company Limited and both the companies have a common director David Patrick Ian Booth.
How does the market perceive Cigarette companies
As on July 3, 2020, the market has valued the three companies similarly. These three companies are almost similar to each other as they are dependant on profit through cigarette and also have a tobacco leaf divisions which process and sell tobacco leaf. All three of them also export processed and unprocessed tobacco leaf. The Forward P/E ratio of the three companies is around 16. VST Industries was trading at a Forward P/E ratio of 16.02. Godfrey Phillips was trading at a lower Forward P/E ratio of 14.02 which could be due to negative growth in earnings.
The market has beaten down ITC the most as the stock price has dropped by 39.40% in the last 3 years. Even in the 1 year period the stock has given a return of -24.99%.
Godfrey Phillips has given a positive return in the last 1 year. Even though VST Industries has given a return of -5.81% in one year period, this stock has been punished the least by the market.
Fundamentals of the companies
All the three companies have almost zero debt. This industry usually does not require huge capex and the product can be moved from one region to another quite easily. Market Capitalization of Godfrey Phillips and VST Industries are at Rs. 5,104 crore and 4,901 crore respectively. If we take a look at the Price to Book Value ratio, then we will find that the market is giving a premium to VST Industries over Godfrey Phillips.
All the three companies had revenue growth in Q4FY20 over Q4FY19. But VST Industries has performed much better than others by clocking a revenue growth of 18.85 per cent YoY. ITC had a double digit PAT growth (YoY) due to the new corporate tax regime as the tax outgo has gone down drastically for the company. Godfrey Phillips' expenditure for the Q4FY20 has increased drastically over Q4FY19 which has led to reduced Net Profit.
Industry Outlook
This is an industry which is easy to understand in terms of business, but it is tough to predict what might adversely hit the industry. Covid-19 had hit the production and sales of cigarette in the country and this has affected all the three companies. Imposition of new and additional taxes on the cigarette industry has already taken a toll. Sales of illegal cigarettes has also grown manifold in the last 2 decades. But the product is such that the demand will be there unless it becomes much more easier and sensible to buy smuggled cigarettes.
The companies are trying to diversify into new businesses to offset the impact of negative image of the product, but it may still take a few more years for these new businesses to earn a meaningful amount of profit for the respective companies. Market hasn't considered Godfrey Phillips' retail business (24Seven) as an entity of considerable value (DMART trades at a PE multiple of 106). Similarly, the market hasn't given any weightage to ITC's FMCG business (Hindustan Unilever is trading at a PE multiple of 70).
All the companies have very low or no debt to worry about. They also have enough reserves to afford capex without looking at external source for debt and new products are being introduced in the market at regular interval. Also, ITC's other businesses, such as Hotel and Paper board for example, may suffer in the short term, but they are strong enough to bounce back.
Even Philip Morris is currently trading at a P/E multiple of 14.34. Indian markets may be following their global peers in valuing the Indian cigarette companies.