ITC’s tobacco business is going cheap but Kotak Institutional Equities thinks market has it wrong
According to Kotak Securities, the implied one-year forward P/E of ITC’s tobacco business is around 11X, based on depressed FY2027-28E earnings per share compared with FY2026 levels. The brokerage said this valuation implies that the market either expects the tobacco business’ earnings to remain stagnant at low levels in perpetuity, believes the value of ITC’s non-tobacco businesses is significantly lower, or has limited appetite for the tobacco business.
Kotak’s valuation assigns a 16X multiple to September 2028E earnings for the tobacco business, resulting in a 12-month fair value of Rs 194. For the non-tobacco business, it uses 30X September 2028E EBITDA to arrive at a 12-month fair value of Rs 80. The brokerage assigns another Rs 84 to ITC’s other businesses and cash.
Tobacco business: What is the market pricing in?
Kotak Securities believes its 16X two-year forward P/E multiple for ITC’s tobacco business is reasonable. The multiple implies 4.8% growth in free cash flow to equity (FCFE) in perpetuity assuming an 11% cost of equity, and 5.8% perpetual FCFE growth assuming a 12% cost of equity.
The brokerage noted that the implied growth in net profit is similar to the PAT growth estimates for major global tobacco companies.
Against this backdrop, the 11X implied P/E for ITC’s tobacco business in the reverse-SoTP valuation suggests that the market either expects earnings to stagnate at low levels in perpetuity or considers Kotak’s near-term earnings estimates for the business too aggressive. Kotak said its assumptions for the tobacco business should address the latter concern.
Non-tobacco business: A high multiple, but faster growth
Kotak Securities acknowledged that its 30X two-year forward EV/EBITDA multiple for ITC’s non-tobacco business may appear aggressive compared with peers, particularly after the sharp derating in their multiples over the past few months.However, the brokerage expects ITC’s non-tobacco business to deliver faster profit growth than other companies. It attributes this to likely stronger growth in several key categories where ITC has lower market shares, along with the scope for margin expansion as the business scales up.
Kotak expects strong growth in revenue and EBIT from the non-tobacco business over the next few years, even with only moderate expansion in its EBIT margin.
Splitting ITC could unlock value
Kotak Securities believes a vertical split of ITC into two separate entities, with the tobacco business housed in one and the non-tobacco businesses in another, could unlock significant value for shareholders.
According to the brokerage, the tobacco entity could attract value-oriented shareholders seeking steady growth and high dividend yields. The non-tobacco entity, meanwhile, could appeal to growth investors as well as a broader pool of investors who may otherwise be deterred by ESG concerns associated with tobacco.
The brokerage’s core argument is that ITC’s current valuation does not appear to fully reflect the value it assigns to the tobacco and non-tobacco businesses separately.
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)
