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I12 · ITC (2014 → 2020 → 2023 → 2026): value trap, re-rating, and the tax that came back

The hook. On 31 March 2014 ITC traded at 32 times earnings. Over the next six and a half years its earnings per share rose 67% and the Nifty rose 74%, yet by 30 October 2020 the share price was 30% lower, at ₹165.25 — 13 times trailing earnings, with a 6% dividend yield, ₹37,000 crore of cash and investments, and the most profitable cigarette franchise in Asia. Investors called it the market's best-known value trap: a tobacco company that kept putting its cigarette cash into biscuits, hotels and paper at single-digit returns, that ESG funds would not own, and whose earnings sat at the mercy of the finance minister. Anyone who bought that day made 47% a year for the next 34 months as the multiple doubled. Anyone who bought after the re-rating, on the day the board approved the hotels demerger in August 2023, lost a quarter of their money by September 2026, after the government replaced the GST cess with a new excise duty and cigarette profits fell. This case is about what "cheap" means for a business with one great segment and several ordinary ones, how to value a conglomerate part by part, and how to price a tax risk that is always present and occasionally realised.
Period FY2013–FY2020 (set-up) · 30 October 2020 (decision A) · FY2021–FY2023 · 14 August 2023 (decision B) · 2023–September 2026 (outcome)
Decision dates A: close of 30 October 2020, ₹165.25 (NSE), market cap ≈ ₹2.03 lakh crore on 1,229.22 crore shares. You may use only what was public by then: annual reports to FY2020 (July 2020), the Q1 FY2021 results (July 2020), the July 2017 GST cess increase and the February 2020 Budget's NCCD increase. The Q2 FY2021 results came out on 6 November 2020, after the decision date. B: close of 14 August 2023, ₹449.20, market cap ≈ ₹5.59 lakh crore on 1,243.95 crore shares. You may use only what was public by then: annual reports to FY2023, the Q1 FY2024 results and the hotels demerger scheme (in-principle approval 24 July 2023; scheme approved by the board on 14 August 2023)
Sector Cigarettes, packaged foods and personal care ("FMCG-Others"), hotels, agri-business, paperboards and packaging (NSE: ITC). Fiscal year ends 31 March
Themes "Cheap for a reason" vs mispriced · sum-of-the-parts and the conglomerate discount · return on incremental capital · sin-tax risk and volume elasticity · payout policy as a valuation driver · ESG exclusion and ownership flows · a large shareholder selling · demerger arithmetic · regulatory tail risk
Modules this case reinforces 04.3 Returns on capital · 05.3 Moats · 05.5 Management & capital allocation · 06.5 Multiples · 06.6 Reverse DCF · 06.7 Other valuation methods (SOTP) · 07.5 Holdcos & conglomerates · 08.3 Consumer · 12.1 Macro for equity investors · 12.3 Special situations
Difficulty Intermediate (★★★☆☆). Do it after Modules 06 and 07. Pairs with I2 Asian Paints (a great business at a high price), G1 See's Candies (where to put a cash cow's cash) and G2 Coca-Cola
Time ~3 hours (two decision points; about 45 minutes on each before you read on)

Conventions in this case

₹ crore unless stated (1 crore = 10 million; 1 lakh crore = 1 trillion). Ten-year tables are consolidated (as compiled by Screener.in); segment data, EPS and dividends used for valuation are standalone, from the annual reports, because that is where ITC reports its segments. Share prices are NSE closes from exchange bhavcopies, not Yahoo Finance, whose history for ITC is adjusted for both the 2016 bonus and the 2025 hotels demerger. Per-share figures before the 1:2 bonus of July 2016 are divided by 1.5. "PBIT" is segment profit before interest and tax; "capital employed" is segment assets less segment liabilities. Bracketed numbers point to the Sources.

1. The scene

1.1 The business (as of October 2020)

ITC began in 1910 as the Imperial Tobacco Company of India, a subsidiary of what became British American Tobacco (BAT). It is now an Indian company with no controlling shareholder: BAT is the largest holder (29.47% at March 2020) but cannot control the board, and Indian institutions (LIC, the Specified Undertaking of the UTI and other state insurers) own a comparable share 1. Its businesses in FY2020 (standalone):

  • Cigarettes. The dominant legal cigarette maker in India, with brands across every length and price point (Gold Flake, Classic, Navy Cut, Scissors, Bristol). Legal cigarettes are a small part of Indian tobacco consumption — most is bidi and chewing tobacco — and a heavily taxed one. Revenue ₹21,202 crore; PBIT ₹14,853 crore, 85% of the group's segment profit 1.
  • FMCG-Others. Aashirvaad atta, Sunfeast biscuits, Bingo snacks, Yippee noodles, Classmate notebooks, and personal care (Savlon, Fiama, Engage). Built from nothing since the early 2000s; revenue ₹12,844 crore but PBIT only ₹423 crore (3.3% of revenue) 1.
  • Hotels. ITC Maurya, ITC Grand Chola and about 100 other hotels, owned or managed; revenue ₹1,837 crore and PBIT ₹158 crore in FY2020, before Covid shut them.
  • Agri-business. Leaf tobacco exports and commodity trading; the sourcing arm for the foods business.
  • Paperboards, paper and packaging. India's largest paperboard maker, with integrated pulp and plantations and a packaging unit that supplies the cigarette business.

Industry and regulation. Cigarette taxes in India are among the highest in the world as a share of price. From July 2017 cigarettes paid 28% GST plus a GST compensation cess (an ad valorem rate plus a specific amount per thousand sticks by length) plus the National Calamity Contingent Duty (NCCD). On 17 July 2017 the GST Council raised the cess days after GST began, and ITC fell 12.5% the next day. The February 2020 Budget raised the NCCD, and the stock fell 6.9% on Budget day 7. Indian cigarette volumes had fallen for most of the 2010s as taxes rose, while illegal (smuggled and counterfeit) cigarettes gained share.

Management and capital allocation. Sanjiv Puri became CEO in 2017 and chairman in 2019, succeeding Y.C. Deveshwar, who had run ITC from 1996 and built the non-cigarette businesses. Management's stated strategy, "ITC Next", was to build FMCG brands and hotels into large profit pools using the cigarette cash flow, and it defended the hotels and paper businesses as strategic 1. In FY2020, 94% of capital expenditure (₹2,315 crore in total) went outside cigarettes: 36% to FMCG-Others, 31% to hotels 1.

1.2 What the market believed, and who disagreed

The bear case (the consensus by 2020). Cigarettes were in structural decline; each Budget carried the risk of a tax shock; ESG mandates excluded tobacco, so a growing share of global money could not own the stock; the non-cigarette businesses destroyed value, earning 5–6% on capital; management would not return the cash or separate the parts; and BAT, the largest shareholder, was itself a tobacco company. The share price was lower than in 2014. Covid had closed the hotels and briefly shut cigarette factories. Foreign ownership was falling 1 8.

The bull case (a minority). Cigarette profits had compounded at about 7% a year even in a falling-volume market, with pricing power and a near-monopoly on legal distribution. The payout ratio had risen to 82% and the dividend yield exceeded the 10-year G-sec (≈5.9%). The non-cigarette capital was sunk, and incremental FMCG margins were improving. At 13 times earnings, the market was pricing a slow death that the numbers did not show.

1.3 The scene at decision B (August 2023)

By August 2023 the stock had nearly tripled. Cigarette volumes had recovered after Covid while GST cess rates stayed unchanged; FMCG-Others margins had doubled; hotels were enjoying a post-Covid boom; paperboards had a cyclical peak. ITC paid out more than 100% of FY2023 earnings, including a special dividend. It crossed ₹5 lakh crore of market value and, for a few days in July 2023, briefly overtook Hindustan Unilever as India's most valuable consumer company 9. On 24 July 2023 the board gave in-principle approval to demerge the hotels business, with ITC keeping about 40% and shareholders receiving the rest; on 14 August 2023 it approved the scheme: one ITC Hotels share for every ten ITC shares 3 4. The market had wanted the hotels out for years; it fell 3.9% on 24 July, disappointed that ITC would keep 40%.

2. The numbers then

2.1 Decision A (October 2020)

Table 2.1: ITC consolidated, FY2015–FY2020 (₹ crore)

FY Sales Operating profit OPM (%) Net profit EPS (₹) Payout (%) ROCE (%) Free cash flow
2015 38,817 14,252 37 9,779 8.04 52 47 6,552
2016 39,192 14,531 37 9,501 7.74 73 40 7,459
2017 42,768 15,470 36 10,477 8.47 56 36 7,556
2018 43,449 16,521 38 11,493 9.24 56 34 10,371
2019 48,340 18,537 38 12,836 10.27 56 34 9,442
2020 49,388 19,344 39 15,593 12.45 82 32 12,276

Source: Screener.in, consolidated 5. EPS is on the post-2016-bonus share count. FY2020 net profit benefited from the cut in the corporate tax rate (tax rate 22% against 33% a year earlier). Sales are net of excise and GST.

Table 2.2: Segment economics, FY2020 (standalone, ₹ crore)

Segment Revenue PBIT PBIT margin (%) EBITDA Capital employed ROCE (%) Share of segment PBIT (%) Share of FY2020 capex (%)
Cigarettes 21,202 14,853 70.1 15,125 2,913 510 84.7 5.6
FMCG-Others 12,844 423 3.3 914 6,561 6.4 2.4 36.2
Hotels 1,837 158 8.6 420 5,788 2.7 0.9 31.2
Agri-business 10,241 789 7.7 862 2,932 26.9 4.5 2.4
Paperboards & packaging 6,107 1,305 21.4 1,663 6,059 21.5 7.4 10.7
Total 17,528 24,253 100 86.1 (13.9 unallocated)

Source: FY2020 annual report, segment note 1. Segment revenue is gross of inter-segment sales, so it does not add to the consolidated figure. EBITDA = PBIT + segment depreciation. ROCE = PBIT ÷ year-end capital employed.

Table 2.3: Where the profit came from, FY2013–FY2020 (standalone, ₹ crore)

FY Cigarette PBIT FMCG-Others revenue FMCG-Others PBIT
2013 8,326 7,012 (81)
2014 10,016 8,122 22
2015 11,196 9,038 34
2016 11,752 9,731 71
2017 12,514 10,512 28
2018 13,341 11,329 164
2019 14,551 12,505 316
2020 14,853 12,844 423
CAGR FY2014–20 6.8% 7.9% —

Source: annual reports FY2014–FY2020 1 2. After roughly fifteen years and several thousand crore of investment, FMCG-Others made ₹423 crore of PBIT on ₹12,844 crore of revenue.

Table 2.4: Valuation at decision A (30 October 2020)

Metric Value Working
Price ₹165.25 NSE close 7
Market cap ₹2,03,129 crore 165.25 × 1,229.22 crore shares
FY2020 standalone EPS / P/E ₹12.31 / 13.4× 1
Trailing-twelve-month EPS / P/E (to June 2020) ₹11.64 / 14.2× Q1 FY2021 hit by lockdown
FY2020 dividend / yield ₹10.15 / 6.1% Payout 82% of standalone profit
Earnings yield vs 10-year G-sec 7.4% vs ≈5.9%
Cash and current investments / plus non-current investments ₹24,018 / ₹37,474 crore ₹19.5 / ₹30.5 per share
Net worth / P/B ₹64,029 crore / 3.2×
Price change since 31-Mar-2014 (bonus-adjusted ₹235.23) −29.8% EPS +67% over the same period; Nifty +73.7%
P/E on 31-Mar-2014 31.9× ₹352.85 ÷ FY2014 EPS ₹11.05 (pre-bonus)
Peers' P/E HUL 66.5×, Nestlé India 84×, VST 17.3×, Godfrey Phillips 12.0× FY2020 / CY2019 earnings
BAT holding / FPI holding 29.47% / 14.63% Shareholding pattern, March 2020

Sources: 1 5 7. The 10-year G-sec yield is approximate. Peer multiples are computed from each company's reported EPS and its NSE close on the same date.

2.2 Decision B (August 2023)

Table 2.5: ITC, FY2020–FY2023 (consolidated unless stated, ₹ crore)

FY Sales Operating profit Net profit EPS (₹) Payout (%) Cigarette PBIT (standalone) FMCG-Others revenue (standalone) FMCG-Others EBITDA margin (%)
2020 49,388 19,344 15,593 12.45 82 14,853 12,844 7.1
2021 49,257 17,065 13,383 10.69 101 n/r n/r n/r
2022 60,645 20,623 15,503 12.37 93 n/r n/r n/r
2023 70,919 25,704 19,477 15.44 100 17,927 19,123 10.2

Sources: 5 2. n/r = not reproduced here. FY2020–23 CAGR: cigarette PBIT 6.5%, FMCG-Others revenue 14.2%.

Table 2.6: Segment economics, FY2023 (standalone, ₹ crore)

Segment PBIT EBITDA EBITDA margin (%) Capital employed ROCE (%) Share of segment PBIT (%)
Cigarettes 17,927 18,196 64.5 2,234 803 76.4
FMCG-Others 1,374 1,954 10.2 9,615 14.3 5.9
Hotels 542 832 32.2 5,574 9.7 2.3
Agri-business 1,328 1,394 7.7 2,465 53.9 5.7
Paperboards & packaging 2,294 2,642 29.1 7,886 29.1 9.8

Source: FY2023 annual report 2.

Table 2.7: Valuation at decision B (14 August 2023)

Metric Value Working
Price ₹449.20 NSE close 7
Market cap ₹5,58,782 crore 449.20 × 1,243.95 crore shares
FY2023 standalone EPS / P/E ₹15.15 / 29.7×
Trailing-twelve-month EPS / P/E (to June 2023) ₹15.67 / 28.7×
FY2023 dividend / yield ₹15.50 incl. ₹2.75 special / 3.45% Payout 103% of standalone profit
Earnings yield vs 10-year G-sec 3.5% vs ≈7.2%
Price change since decision A +171.8% Nifty +66.9%
Peers' P/E HUL 59.7×, Nestlé India 88×, VST 16.3×, Godfrey Phillips 17.4× FY2023 / CY2022 earnings

2.3 What the filings said (paraphrased)

  1. FY2020 annual report 1. The chairman described the non-cigarette businesses as "future engines of growth" and set out the "ITC Next" strategy of building brands, digital capability and "Indian agriculture"-linked supply chains. The report highlighted that FMCG-Others had become the second-largest packaged-foods business in India and that its EBITDA margin had improved for several years running. It emphasised the social and environmental credentials of the group (carbon, water and solid-waste positive).
  2. Taxation. The report described the cigarette tax regime as "discriminatory" and "punitive", pointing to the share of illicit trade and to legal cigarettes' small share of tobacco consumption, and argued for a "stable, equitable and pragmatic" tax policy 1.
  3. Payout. The board had raised the payout ratio in stages to 82% of standalone profit in FY2020 1.
  4. The demerger media statement (24 July 2023) 3. The board had "evaluated and discussed various alternative structures for the Hotels Business" and chose a demerger into a new listed entity, with ITC holding about 40% and shareholders about 60%, so that the hotels could have their own capital structure and investors.
  5. The scheme (14 August 2023) 4. Share entitlement: one ITC Hotels share of ₹1 for every ten ITC shares of ₹1; ITC to keep ~40%; subject to shareholder, creditor, stock-exchange and NCLT approvals.

3. You are the analyst

Answer these before reading section 4, using only sections 1 and 2. Show your arithmetic.

Decision A: 30 October 2020 (₹165.25)

  1. (Numerical — sum of the parts.) Value each segment from Table 2.2: cigarettes at 12× EBITDA (a discount to a global tobacco multiple, to reflect tax risk), FMCG-Others at 3× revenue (a heavy discount to HUL and Nestlé, reflecting its low margin), hotels at 20× FY2020 EBITDA, paper and agri at 8× EBITDA. Add ₹37,474 crore of cash and investments (ITC has almost no debt). What is the value per share? Then turn it round: what multiple of cigarette EBITDA, and of cigarette PBIT after tax (25.17% rate), is the market paying once the other parts and the cash are valued as above?
  2. (Numerical — return on incremental capital.) From Table 2.2, compute the combined PBIT, capital employed and ROCE of FMCG-Others and hotels. At an 11% pre-tax cost of capital, what is the annual shortfall in rupees? What share of FY2020 capex went into these two segments? Is the market's "value destruction" argument about the stock of capital already invested or the flow of new investment — and which matters more for the share price?
  3. (Numerical — the tax sensitivity.) Assume a tax increase is passed through in full, so the cigarette margin per stick is unchanged, and volumes respond to price with an elasticity of −0.4. Compute the change in cigarette PBIT and in group EPS (cigarettes = 84.7% of segment PBIT) for retail price increases of 10%, 15% and 20%, the last two with elasticities of −0.5 and −0.6. How does that compare with the 12.5% one-day fall in July 2017?
  4. (Numerical — what does the price imply?) With a dividend of ₹10.15 and a cost of equity of 11%, solve the Gordon model for the perpetual dividend growth the price implies. Repeat at 10% and 12%. Compare with the 6.8% cigarette PBIT CAGR and the 9.5% PAT CAGR of FY2014–FY2020.
  5. (Judgement — why is it cheap?) List every reason the stock de-rated from 32× to 13× while EPS rose 67%. For each, say whether it is a cash-flow reason (the future profits are lower or riskier) or a demand-for-the-stock reason (fewer buyers regardless of cash flows), and what evidence would reverse it.
  6. (Decision A.) Build three three-year scenarios — bear (EPS +2% a year, P/E 11×), base (EPS +7%, P/E 16×), bull (EPS +10%, P/E 22×) — with an 85% payout. Compute the total return and annualised return of each from ₹165.25. Buy, avoid or short? How much would you own?

Decision B: 14 August 2023 (₹449.20)

  1. (Numerical — decompose A → B.) Using TTM EPS of ₹11.64 at A and ₹15.67 at B, split the price change from ₹165.25 to ₹449.20 (2.79 years) into EPS growth and P/E change, and add the ₹37.75 of dividends paid in between. What share of the return was the re-rating?
  2. (Numerical — how big is the hotels demerger?) Value the hotels business at 20×, 25× and 30× its FY2023 EBITDA (₹832 crore). What is the 60% going to shareholders worth per ITC share, and as a percentage of the ₹449.20 price? What does that tell you about whether the demerger explains the re-rating?
  3. (Numerical — the tax tail.) Cigarettes are 76.4% of segment PBIT at B. If a tax change cut cigarette PBIT by 10%, 20% and 30%, what happens to EPS? What price results at the current 29.7× P/E, and at 20×? How far could the stock fall?
  4. (Decision B.) Build three three-year scenarios from ₹449.20 — bear (EPS +3% a year, exit P/E 18×), base (+8%, 24×), bull (+11%, 30×) — with a 95% payout. Hold, buy more or sell? How does your answer depend on what you believe about the probability of a tax shock?

4. What happened

flowchart LR
  A["30-Oct-2020<br/>₹165.25 · 13.4×<br/>yield 6.1%"] --> B["FY2021–23<br/>volumes recover; cess unchanged;<br/>FMCG margin 7%→10%;<br/>payout ≥100%"]
  B --> C["24-Jul / 14-Aug-2023<br/>hotels demerger;<br/>₹449.20 · 29.7×"]
  C --> D["13-Mar-2024<br/>BAT sells 3.5%<br/>(stock +4.5%)"]
  D --> E["26-Sep-2024<br/>peak ₹522.75"]
  E --> F["Jan-2025<br/>demerger effective;<br/>ITCH listed at ₹171.85"]
  F --> G["28-May-2025<br/>BAT sells ~2.5% more"]
  G --> H["Dec-2025 / Jan-2026<br/>excise law passed;<br/>notified 31-Dec; −13% in 2 days"]
  H --> I["Sep-2026<br/>₹270.15 · 16× FY26;<br/>Q1 FY27 PAT −27%"]

2020–2023: the re-rating. The Q2 FY2021 results on 6 November 2020 showed cigarette revenue recovering and FMCG-Others EBITDA up 66% with margins at 9.7% 6. Over the next three years three things happened at once. Cigarette taxes did not rise: the GST compensation cess rates, which the finance minister later noted were unchanged from July 2017, stayed where they were, and volumes recovered from Covid 10. The non- cigarette businesses improved: FMCG-Others' EBITDA margin rose from 7.1% to 10.2% and its revenue grew 14% a year; hotels rebounded; paperboards had a cyclical peak. And the payout rose to 100% or more. EPS grew about 11% a year; the P/E doubled. From ₹165.25 the stock reached ₹449.20 on 14 August 2023 — with dividends, 47% a year for 34 months 5 7.

2023–2025: the peak, BAT and the demerger. On 13 March 2024 BAT sold about 3.5% of ITC (43.7 crore shares) in an accelerated bookbuild, cutting its stake to about 25.5%; the overhang cleared and the stock rose 4.5% 11. ITC closed at a record ₹522.75 on 26 September 2024. The hotels demerger became effective on 1 January 2025 (record date 6 January). In the special pre-open session on 6 January, ITC's price fell from ₹481.60 to ₹455.60 — an implied ₹26 per ITC share, or ₹260 per ITC Hotels share. ITC Hotels listed on 29 January 2025 and closed its first day at ₹171.85, a third below that discovery price. For tax purposes ITC told shareholders to allocate 86.49% of their cost to ITC and 13.51% to ITC Hotels 4 7. On 28 May 2025 BAT sold roughly another 2.5% at around ₹400–417 a share, leaving it with about 23% (22.91% at March 2026) 12; in December 2025 it launched a block sale of its 15.3% stake in ITC Hotels.

December 2025–September 2026: the tax came back. The GST compensation cess, levied since 2017 to compensate states for GST revenue losses, was due to end once the borrowing it serviced was repaid. The government's answer for tobacco was to restore a central excise duty. Parliament passed the Central Excise (Amendment) Bill, 2025 in December 2025; the finance minister said it was "not a new law and not even an additional tax" but a return to the pre-GST excise, with the cess "reverting back to the Centre to be collected as excise duty", and noted that total tax incidence on cigarettes was 53% of retail price 10. The notification on 31 December 2025 set a specific excise of ₹2,050 to ₹8,500 per 1,000 sticks, by length, effective 1 February 2026, alongside a 40% GST rate in place of 28% plus cess. Analysts said the combined increase was much larger than expected; Religare estimated costs in the 75–85mm segment (16% of ITC's volume) would rise 22–28%. ITC fell 9.7% on 1 January 2026, its largest one-day fall since March 2020, and another 3.8% the next day; Godfrey Phillips fell 17% 13.

ITC responded with staggered price increases and "over 30 interventions" to re-engineer its portfolio, to limit the shift to illicit cigarettes. FY2026 was still a growth year: consolidated PAT rose 4.9%, and the board paid ₹14.50 a share. But the first full quarter under the new tax, Q1 FY2027, showed standalone EBITDA down 28% and PAT down 27% year on year, even as FMCG-Others revenue grew 12% and its PBIT 21% 14. On 23 September 2026 ITC closed at ₹270.15 — 16.4× FY2026 consolidated EPS of ₹16.51, with a 5.4% trailing dividend yield — after touching ₹255.50 on 31 August 2026 5 7. ITC Hotels closed at ₹161.23.

The returns. Holding one ITC share plus the 0.1 ITC Hotels share it received:

Holder Start Value on 23-Sep-2026 (ITC + 0.1 ITCH) Dividends received (not reinvested) Total Annualised Nifty (price)
Bought at A (30-Oct-2020) ₹165.25 ₹286.27 ₹80.35 (+₹0.10 from ITCH) 2.22× 14.5% 2.01× (12.6%)
Bought at B (14-Aug-2023) ₹449.20 ₹286.27 ₹42.60 (+₹0.10) 0.73× −9.5% 1.21×

Sources: bhavcopy and Yahoo Finance closes and ITC dividend history 7; ITC Hotels paid a ₹1 dividend in 2026. From the September 2024 peak to 31 August 2026 the combined position fell 48%.

5. Signals: knowable then vs hindsight

Knowable at the decision date Only in hindsight
A: Cigarette PBIT had compounded ~7% a year for six years with a 500%+ ROCE; payout had risen to 82%; the dividend yield exceeded the G-sec That three years would pass without a cigarette tax increase
A: A sum-of-the-parts with conservative multiples gave ~₹233 a share; the market was paying about 6.5× cigarette EBITDA once the rest was valued That FMCG-Others margins would rise three points and hotels boom after Covid
A: The de-rating was largely about demand for the stock (ESG exclusion, falling FPI ownership, BAT overhang, "value trap" narrative) rather than falling cash flows That domestic institutions would absorb the supply and that BAT's sales would be seen as clearing an overhang
B: 29.7× earnings and a 3.5% earnings yield against a 7.2% G-sec, for a business whose profit was 76% cigarettes The timing and design of the excise duty that replaced the cess
B: The cess was temporary by law; its end was public, and a replacement tax on cigarettes was a stated policy option That Q1 FY2027 profit would fall 27%
B: The hotels demerger was worth only ~2% of ITC's market value; it could not justify a re-rating That ITC Hotels would list a third below the discovery price

The strongest bear case at A — and the strongest bull case at B

Bear at A (October 2020). Legal cigarette volumes had fallen for a decade; illicit trade was rising; every Budget was a coin toss; ESG exclusion would keep shrinking the buyer base; management had spent fifteen years and thousands of crores building businesses that earned less than their cost of capital and showed no intention of stopping or splitting them. "Cheap for a reason" — the stock had lost 30% in six years while its earnings rose.

Bull at B (August 2023). ITC had finally shown that FMCG could earn double-digit margins, the hotels were being separated, the payout was over 100%, BAT was a willing seller whose supply was being absorbed, and domestic investors owned a growing share. At 30× it was still cheaper than HUL or Nestlé.

Each side was right about the facts it chose. The bear at A was right that the tax risk was permanent — and wrong that it was about to be realised, at a price that already assumed it. The bull at B was right that the business had improved — and wrong to pay a consumer-staples multiple for a business whose profit remained three-quarters cigarettes. The same tax risk was mispriced in opposite directions three years apart.

6. Lessons

  1. "Cheap for a reason" needs the reason sorted into cash flows and flows of money. ITC's 2014–2020 de-rating happened while earnings rose 67%. Reasons that change future cash (tax, volumes, value-destroying capex) belong in the valuation; reasons that change who can buy (ESG exclusion, a large seller) create opportunities when the price already discounts them. → 06.5 Multiples · 12.2 Market cycles & sentiment
  2. Value a conglomerate part by part, then ask what the market pays for the core. At A, once the other businesses and the cash were valued generously, the market was paying about 9× after-tax cigarette profit — a price for a declining business, attached to one that was growing. → 06.7 Other valuation methods (SOTP) · 07.5 Holdcos & conglomerates
  3. Distinguish the stock of bad capital from the flow. ITC's ₹12,000 crore in FMCG-Others and hotels earned about 5% — a sunk cost. What mattered for the share price was whether new money would keep going in at those returns, and whether margins on the existing capital would rise. Both improved after 2020. → 04.3 Returns on capital · 05.5 Management & capital allocation
  4. Payout policy is a valuation lever. Raising the payout from 52% to 100% converted an argument about capital allocation into a cash yield above the risk-free rate — and removed much of the "they will waste the cash" discount. → G1 See's Candies · 06.1 What value is
  5. Sin-tax risk is a permanent tail; price it as a probability, not a certainty or an impossibility. At A the price implied perpetual decline; at B it implied tax stability for a business whose tax was set annually by the state. The same risk was underpriced at the peak and overpriced at the trough. → 12.1 Macro & policy · 06.8 Margin of safety
  6. Read the sunset clauses. The GST compensation cess had a legal end; a government that depends on tobacco revenue was always going to replace it. Scheduled regulatory changes belong in the monitoring list years ahead. → 11.5 Monitoring & selling
  7. A demerger's value is its size, not its headline. The hotels were 2–3% of ITC's value. Re-ratings attributed to small corporate actions are usually about something else. → 12.3 Special situations
  8. Multiples of mixed businesses drift toward the multiple of their largest profit pool. Paying a staples multiple for a company whose profit was 76% cigarettes relied on the market continuing to see it as a staples company. → 08.3 Consumer

7. Model answers

Q1 — Sum of the parts (A)

Cigarettes 15,125 × 12 = ₹1,81,500 crore; FMCG-Others 12,844 × 3 = ₹38,533 crore; hotels 420 × 20 = ₹8,400 crore; agri 862 × 8 = ₹6,896 crore; paper 1,663 × 8 = ₹13,304 crore; cash and investments ₹37,474 crore. Total ₹2,86,107 crore = ₹232.8 a share, 41% above ₹165.25. With cigarettes at 10× the answer is ₹208; at 8×, ₹184.

Turning it round: the market cap of ₹2,03,129 crore less the other parts and the cash (₹1,04,607 crore) leaves ₹98,522 crore for the cigarette business — 6.5× its EBITDA and 8.9× its after-tax PBIT (14,853 × 0.7483 = ₹11,114 crore). That is the multiple of a business expected to shrink steadily, applied to one whose profit had grown 6.8% a year. Even if FMCG-Others were valued at zero, cigarettes would be priced at under 9× EBITDA.

Q2 — Return on incremental capital (A)

FMCG-Others + hotels: PBIT 423 + 158 = ₹581 crore on capital employed 6,561 + 5,788 = ₹12,349 crore — a ROCE of 4.7%. At 11% the required PBIT is ₹1,358 crore, a shortfall of ₹778 crore a year (about ₹0.63 a share before tax). FY2020 capex into the two segments: 36.2% + 31.2% = 67% of ₹2,315 crore, i.e. ₹1,560 crore.

The stock (₹12,349 crore) is sunk: it matters only through what it earns from here. The flow (₹1,500–2,000 crore a year) is the live decision: every rupee earning 5% against an 11% cost destroys about half its value. What the share price needed was either higher returns on the stock (margins rising) or less flow (capex falling relative to cash generation, and the rest paid out). The 82% payout had already capped the flow; the margin improvement came after.

Q3 — The tax sensitivity (A)

With full pass-through and a constant margin per stick, cigarette PBIT moves with volume. Price +10%, elasticity −0.4: volume −4.0%, cigarette PBIT −4.0%, group EPS −0.847 × 4.0 = −3.4%. Price +15%, −0.5: volume −7.5%, EPS −6.4%. Price +20%, −0.6: volume −12%, EPS −10.2%. The 12.5% one-day fall in July 2017 was larger than even the worst of these earnings effects — the market was pricing the multiple (the perceived permanence and repetition of tax risk), not only the earnings hit. If ITC does not pass the tax through in full, margin falls too and the EPS effect roughly doubles, which is what Q1 FY2027 later showed.

Q4 — What the price implies (A)

Gordon: P = D₀(1 + g) ÷ (r − g) → g = (rP − D₀) ÷ (P + D₀). At r = 11%: (0.11 × 165.25 − 10.15) ÷ (165.25 + 10.15) = 4.6%. At 10%: 3.6%; at 12%: 5.5%. The price assumed dividends would grow at 3.5–5.5% forever — roughly inflation — for a company whose cigarette PBIT had grown 6.8% and profit 9.5% a year for six years. It was a price for real decline in a business that had not been declining.

Q5 — Why is it cheap? (A)

Cash-flow reasons: (1) tax shocks (2017 cess, 2020 NCCD) — lower and riskier future profits; (2) legal volumes falling and illicit trade rising; (3) capital put into low-return businesses; (4) Covid hitting hotels and, briefly, cigarettes. Demand-for-the-stock reasons: (5) ESG exclusion shrinking the pool of buyers; (6) falling FPI ownership (14.6%); (7) BAT, a 29% holder, seen as a potential seller; (8) the "value trap" narrative itself — momentum and underperformance feed on each other.

Reversal evidence: a year without a tax increase; FMCG-Others margins rising; capex falling relative to cash flow and payout rising; domestic institutions and retail absorbing supply; BAT's intentions clarified. The cash-flow reasons were partly priced; the demand reasons were, by nature, reversible without any change in the business.

Q6 — Decision A

From EPS ₹12.31, 85% payout, three years:

Scenario EPS year 3 Price year 3 Dividends Total multiple Annualised
Bear (+2%, 11×) 13.06 143.7 32.7 1.07× 2.2%
Base (+7%, 16×) 15.08 241.3 36.0 1.68× 18.8%
Bull (+10%, 22×) 16.38 360.5 38.1 2.41× 34.1%

Even the bear case returns roughly the cash yield; the base case needs only a partial re-rating. The asymmetry favoured buying, sized for the tax tail: a 4–6% position, with the max-loss rule applied to a scenario in which a tax shock takes the stock down 30% (11.4). The outcome to August 2023 exceeded the bull case, because both EPS and the multiple did better.

Q7 — Decompose A → B

Price 449.20 ÷ 165.25 = 2.72× over 2.79 years (43.2% a year). EPS 15.67 ÷ 11.64 = 1.35× (11.3% a year). P/E 14.2× → 28.7× = 2.02× (28.7% a year). With ₹37.75 of dividends, the total was 2.95× (47.4% a year). About 70% of the price return (in log terms) was the re-rating — the market changed its mind about ITC far more than ITC's earnings changed.

Q8 — How big is the hotels demerger? (B)

Hotels EV at 20×, 25×, 30× of ₹832 crore EBITDA = ₹16,640, ₹20,800, ₹24,960 crore. The 60% going to shareholders is worth ₹8.0, ₹10.0 and ₹12.0 per ITC share — 1.8%, 2.2% and 2.7% of the ₹449.20 price (the whole hotels business, ₹13–20 a share). Capital employed was ₹4.48 a share. The demerger could not explain a tripling; at most it removed a small drag on returns and signalled a management more willing to act for shareholders. (In hindsight, the market priced ITC Hotels at ₹26 per ITC share on 6 January 2025, then valued it at ₹17 on listing day.)

Q9 — The tax tail (B)

EPS effect ≈ cut × 76.4% (treating segment PBIT shares as profit shares). Cigarette PBIT −10%: EPS ₹14.47 (−7.6%); at 29.7× → ₹430; at 20× → ₹290 (−36%). −20%: EPS ₹13.28 (−15.3%) → ₹394 at 29.7×, ₹266 (−41%) at 20×. −30%: EPS ₹12.08 (−22.9%) → ₹359, ₹242 (−46%). The earnings effect alone is modest; the danger is the multiple, which at B assumed tax stability. A tax shock that also resets the P/E to 20× costs 36–46%.

Q10 — Decision B

From EPS ₹15.67, 95% payout, three years:

Scenario EPS year 3 Price year 3 Total multiple Annualised
Bear (+3%, 18×) 17.12 308.2 0.79× −7.5%
Base (+8%, 24×) 19.74 473.8 1.17× 5.4%
Bull (+11%, 30×) 21.43 642.9 1.55× 15.8%

The base case returns less than the G-sec; the bull case needs the multiple to hold at 30× and growth to accelerate. If you attach even a 30% probability to a tax shock within three years (Q9: −36% to −46%), the expected return is below the risk-free rate. Trim or sell; if held, size it as a yield position with the tax tail explicit. The actual outcome was close to the bear case: EPS grew, then the tax arrived, and the stock returned −9.5% a year including dividends.

8. Discussion questions & extensions

  1. Rebuild the SOTP today. Using the FY2026 annual report and current market prices, value ITC's parts (including its 40% of ITC Hotels at market). What multiple of after-tax cigarette profit does ₹270 imply? Is it closer to A or to B?
  2. Illicit trade as the elasticity. Industry bodies argue that higher taxes shift consumption to smuggled cigarettes rather than reducing it. Find two independent estimates of illicit trade's share in India. How would you build that into the volume elasticity in Q3?
  3. ESG exclusion and returns. ITC holds an MSCI ESG "AA" rating for its environmental record, yet many funds exclude tobacco. Does exclusion raise a stock's expected return (a lower price for the same cash flows)? Compare ITC's 2014–2020 and 2020–2023 returns and discuss.
  4. Compare two de-ratings. I2 Asian Paints de-rated from 97× because a competitor arrived; ITC re-rated and then de-rated because a tax did not come and then came. Which risk was easier to see in advance, and which was priced better?
  5. BAT's sales. BAT sold about 6% of ITC in 2024–25 and put its ITC Hotels stake up for sale. Model the supply as a share of average daily turnover and discuss how block sales to institutions differ from market selling (12.3).

Sources

All accessed 23-Sep-2026.

Notes on sources. Share prices are NSE bhavcopy closes (archive files reached through 7) and, for 2025–2026 and ITC Hotels, NSE closes via Yahoo Finance. Segment figures for FY2013–FY2019 come from the annual reports for those years at the same itcportal.com address pattern as 1 and 2. The Q1 FY2027 figures in section 4 are from ITC's media statement for the quarter ended 30 June 2026 (on itcportal.com and BSE), and the FY2026 dividend from the Q4 FY2026 statement. Source 9 reports ITC briefly overtaking HUL in market value amid the July 2023 demerger talk (on 6 July 2023 the exchange sought ITC's clarification of a media report on the demerger). The 10-year G-sec yields at the two decision dates are approximate (RBI data).

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