ITC can be good long-term bet despite strain on cigarettes, FMCG segments

The September quarter performance of cigarettes major ITC brings out one more area of concern for investors in the stock. Even as declining volume growth in cigarettes remains a challenge, the growth of its fast moving consumer goods ( FMCG) division, set up as a diversification bet, is showing signs of weakness.

The growth of the FMCG business, in which ITC has been investing, has slipped to 7% from 10-12% a year ago. The prolonged weakness in the instant noodles category impacted the segment’s performance. With the cigarettes business mired in regulatory and tax-related pressures, the prospects of the FMCG business, despite being smaller in size, appeared attractive.

However, the September quarter earnings exposed the fragile growth of this loss-making segment. The saving grace for ITC is its high profitability. At 40.4%, the operating profit margin is the highest in eight quarters. The high quality of earnings gives the company the appetite and patience to invest in sectors like FMCG where establishing and servicing brands requires deep pockets.

The ITC stock has not moved much in the past two years. While this is frustrating for short-term investors, for those with a long- term investment horizon, this provides an opportunity to buy the stock at an attractive price.

ITC’s business model is a long-term growth story in the making. As the company retains its market leadership in an addictive product like cigarettes, it is deploying its free cash flows to grow other businesses like FMCG and hotels. There are no near-term growth triggers for the company. The stock, trading at 28 times trailing four quarters earnings, is the cheapest among major FMCG stocks.