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    Why it makes sense to have ITC in your portfolio

    Synopsis

    Not BFSI stocks, go for FMCG plays with attractive valuations, says Rajiv Thakkar

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    The long-term underperformance has increased ITC’s attractiveness from the valuation point of view and we have seen this kind of a cycle play out in many leading companies, says Rajeev Thakkar, CIO, PPFAS MF.

    The top India holding of the scheme which you manage is ITC. It has deep value but then there is an ESG angle and the cigarette business is contracting. The FMCG business turnover is not generating sufficient profitability. The stock could remain depressed for long?
    All these are very valid concerns and another pain point for investors is that people who have bought it three to five years back have seen negative returns. That is a pain point for many. Cigarette is a demerit good in the eyes of society and the government which brings in punitive rates of taxation. The volume growth has not come in two or three decades meaning that either the consumption is flattish or marginally declining. So that obviously is a negative in terms of longer term prospects.

    But at the same time, one has to recognise two or three things which cause us to increase the stake in the recent months. ITC entered the portfolio in March of 2020. Firstly the long-term underperformance has increased the attractiveness from the valuation point of view and we have seen this kind of a cycle play out in many leading companies.

    Market memory is short but if you go back in time and look at Hindustan Unilever or Nestle, for periods of five years and ten years, the stocks underperformed the market significantly. From 2003 to 2007 was one of the strongest bull markets in India, Lever was a big underperformer in that market. When there is a big underperformance, valuation becomes attractive and that is point number one.

    Again one of the biggest concerns of investors has been the capital allocation policy of ITC. A lot of cash flow was going into low ROCE businesses like hotels and it has clearly been stated by the management that they will complete the existing projects but they are not going to start new hotel projects or deploy more capital into low ROCE businesses. The company’s capital allocation policy has improved in recent times.

    The other factor is that the investments in the new FMCG category had a long gestation period and we are now coming out of that . Today the question is these are low margin businesses while earlier these were loss-making businesses. In any business, there is an up-fronted fixed expenditure, there is a lot of expenditure on advertising and brand building and it takes a while for the product to get market acceptance.

    We are at a stage where product acceptance is coming in and that is becoming a bigger piece of the pie and some day there will be a situation where you could see ITC as more of an FMCG play rather than a pure cigarette play. Cigarettes of course will be there for many years to come but the current lens that investors view ITC with, which is only as a cigarette business, could change down the road.

    On ESG (environment, social & corporate governance), it is not a black and white thing. If you look at the ESG ratings of an independent agency like Morningstar, it is valued on various parameters. ITC is doing very well with regards to purchasing renewable energy for their energy needs or being carbon neutral or not consuming water and things like that.

    The cigarette business is anti-society or harmful to the consumer kind of a product but their agri or the new FMCGs businesses are not. There are shades of grey. Obviously some people will not buy it because of their cigarette business but it is a well-governed company in terms of corporate governance, environmental impact is not there but in terms of adding carbon, etc. They harm the consumer and so it is negative on the societal impact front. On balance, in the current environment, where traditional BFSIs are under a cloud of uncertainty, FMCG plays with very attractive valuations deserve a place in the portfolio.

    Would you continue to increase the weightage of IT vis-à-vis some of the other pockets like banking?
    We have not been adding significantly in terms of IT stocks, The weightage increase in companies like Persistent and Mphasis in our portfolio has gone up because of the price outperformance rather than our buying more shares from the open market. So the weightage is purely a function of the market prices.

    About global tech, so while everything gets classified as tech, they are meeting different needs of consumers. Is Amazon a tech company or a retailing company? In fact the global pandemic actually has been something like made to order for these companies because the pre-existing trends have got accelerated. The shift from physical stores to e-commerce, premise computing to Cloud computing, linear television to streaming, print and outdoor media to digital advertising, work from home and consequent impact on companies like Microsoft and all the trends have accelerated the business for these companies.

    While stock prices have gone up somewhat sharply, the business has also increased and so we are staying invested in that space as well.

    Why are you not increasing exposure to Indian IT then?
    Just for context, the share prices of some of these companies have doubled from March. So even by not doing anything, the weightage has gone up very significantly in these companies. We added quite a bit in March and April. We added a new company Oracle Financial Services Software and we added to our existing positions of Persistent and Mphasis and even the global companies. The sharp price increase has been very, very sharp. The latest fact sheet has Persistent as the top holding as even without adding shares, the weightage has gone up.

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    10 Comments on this Story

    Izzam Jaffar7 days ago
    I do not invest in MF. 3 years back, spent a month analysing over 100 Funds for my daughter. Rated Parag Parkh MF, a fund most people didn't know of then, amongst the top 2. With CIO's of this caliber, I am least surprised.
    R P Monani9 days ago
    I have been investing in ITC since 1983 and even today I continue to do so. 100% professionaly managed,transparency in business, high ethics,good policy to reward investors....all make ITC a good bet to buy with a long term perspective. Now is the best time to buy.
    jigish vasa9 days ago
    One will give advice to buy ITC only with vested interest. None of the MF managers are dependable for any advices.
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