Innovate , Sustain, Thrive: The ITC Advantage

VALUE-BASED MANAGEMENT  (VBM)

Value-based management (VBM) is a philosophy and approach that focuses on creating and maximizing shareholder value. VBM emphasizes the importance of making decisions that align with the company's long-term goals and are designed to increase shareholder returns.

Fundamental principles of VBM include:

Focus on shareholder value: VBM prioritizes creating value for shareholders, who are the company's owners. This means that all decisions should be made to increase shareholder wealth.

Long-term perspective: VBM takes a long-term view of decision-making instead of a short-term focus on quarterly earnings. This is because value creation is often a long-term process that requires patience and perseverance.

Use of financial metrics: VBM uses a variety of financial metrics to measure and track value creation, such as economic value added (EVA), discounted cash flow (DCF), and return on invested capital (ROIC).

Relevance of VBM:

VBM is a relevant and vital management philosophy for several reasons:

It aligns the interests of managers and shareholders: VBM helps to ensure that managers make decisions that are in the best interests of shareholders, as their compensation is often tied to shareholder value creation.

It provides a framework for making sound financial decisions: VBM provides a clear framework for making financial decisions aligned with the company's long-term goals.

It can improve shareholder returns: Studies have shown that companies that adopt VBM practices tend to outperform companies that do not.

ITC: A Legacy of Value Creation

ITC Limited, an Indian multinational conglomerate company, has established itself as a beacon of value creation for its shareholders over the long run. Its diversified presence across industries and commitment to innovation, sustainability, and ethical practices have propelled the company to the forefront of India's corporate landscape. ITC is a testament to value creation's power over the long haul. From humble beginnings as a tobacco company, it has transformed into a diversified conglomerate with a presence across industries. ITC's success story is deeply rooted in its unwavering commitment to value creation. The company has consistently demonstrated its ability to generate superior returns for its shareholders, outpacing industry benchmarks.

A Glimpse into ITC's Journey

Established in 1910 as the Imperial Tobacco Company of India Limited, ITC has undergone a remarkable transformation, evolving into a conglomerate with a diverse portfolio spanning FMCG, hotels, packaging, paperboards, specialty papers, and agribusiness. The company's success hinges on its ability to identify and capitalize on emerging opportunities, consistently adapting to the changing market landscape.

Why ITC Ltd..?

Filter used for Screening using EQS function in Bloomberg

WACC Return on Invested Capital

WACC Economic Value Added

Debt/Equity Ratio

ITC Limited is the only company on the list within the top 10 companies ranked using the highest EVA with nearly 0% debt level. 

Unveiling the Drivers of ITC's Value Creation

Quantitative and qualitative factors drive ITC's value-creation journey. On the quantitative front, the company boasts impressive financial metrics, including:

·       Robust ROE: ITC's consistently high ROE, indicating efficient utilization of shareholder capital, is a testament to its financial acumen.

·       Healthy Dividend Payout: ITC's strong track record of dividend payments reflects its commitment to rewarding its shareholders.

·       Exceptional Growth: ITC has consistently grown revenue, profits, and market capitalization, outpacing industry benchmarks and highlighting its ability to navigate the dynamic market landscape.

Qualitative Drivers of Value Creation:

·       Exemplary Management: ITC's leadership team is widely recognized for its strategic vision, operational efficiency, and commitment to ethical practices. Their ability to steer the company through the ever-changing business environment has been instrumental in its success.

·       Innovation-Driven Culture: ITC fosters a culture of innovation, constantly introducing new products and processes to enhance its competitive edge. This commitment to innovation has enabled the company to stay ahead of the curve and adapt to changing consumer preferences.

·       Sustainability Commitment: ITC is a pioneer in sustainability practices, integrating environmental and social considerations into its business operations. This commitment to sustainability has enhanced the company's reputation and contributed to long-term value creation.

·       Beyond the numbers, its success is also attributed to qualitative factors such as:

·       Strong Brand Portfolio: ITC boasts a strong portfolio of well-recognized brands, including Aashirvaad, Biryani, Classmate, and ITC Hotels. These brands have built consumer trust and loyalty, contributing significantly to the company's market share and profitability.

·       Distribution Network: ITC's extensive distribution network, spanning rural and urban areas, ensures its products reach a broad customer base. This robust network has been instrumental in driving revenue growth and brand penetration.

·       Focus on Research & Development: ITC invests heavily in research and development, constantly seeking innovative solutions to enhance product quality, improve processes, and develop new products. This focus on innovation has been a critical driver of the company's success.

·       Corporate Social Responsibility: ITC is committed to fulfilling its social responsibilities, actively engaging in initiatives that contribute to the betterment of society. This commitment to CSR has enhanced the company's reputation and fostered a sense of purpose among its employees.

The various measures of Value-Based Management of ITC are calculated as below:

Residual Income 

Residual income measures the amount by which a company's net income exceeds its cost of equity. It represents the economic value added by the company after considering the expected return demanded by its shareholders.

 In 2022, ITC's residual income was $114459.21 million, which increased to $17353.446 million in 2023. This positive trend indicates that ITC is generating more value for its shareholders beyond the cost of equity. The increase in residual income suggests improved financial performance and shareholder wealth creation.

The cost of equity is a critical factor in residual income calculations. The decreasing cost of equity (from 12% in 2022 to 10% in 2023) contributes to the rise in residual income. A lower price of equity implies that ITC is seen as less risky, potentially attracting more investors.

ITC demonstrated improved profitability, reduced perceived risk, and increased shareholder value, as reflected in the positive trend of residual income from 2022 to 2023. This could indicate effective management and positive financial prospects for the company.

 

EVA

EVA measures a company's economic profit calculated as NOPAT minus the cost of capital multiplied by the total capital employed. In 2022, ITC's EVA was $6952.471 million, increasing significantly to $10248.31 million in 2023. This substantial increase suggests that ITC is creating more economic value for its investors, as the company's profits surpass the cost of capital by a more significant margin.

The Weighted Average Cost of Capital (WACC) represents the cost of funds for a company. When EVA is positive and increasing, as seen in ITC's case, it suggests that the company is earning more than its cost of capital. A rising EVA often indicates effective strategic decision-making and operational efficiency. It means that ITC is deploying its resources in a manner that covers its costs and generates surplus returns.

The company has experienced improved operating profitability, a significant debt cost reduction, and a substantial increase in EVA, indicating enhanced economic value creation for shareholders. These factors collectively suggest positive financial performance and effective capital management by ITC.

EVA vs. Residual income 

 

Both EVA and Residual Income are measures of economic profit and value creation.

EVA considers the entire capital structure, including both debt and equity, in its calculation, while Residual Income focuses specifically on equity.

The critical difference lies in how the cost of capital is factored: EVA uses the weighted average cost of capital (WACC), whereas Residual Income uses the cost of equity.

Return on Invested Capital (ROIC):

ROIC is a financial metric that assesses the efficiency of a company in generating returns from the total capital invested, including both equity and debt. It is calculated by dividing Net Operating Profit After Tax (NOPAT) by the entire invested capital.

ROIC has decreased from 4.14 in 2022 to 3.93 in 2023. This ratio gauges the company's efficiency in generating returns from its invested capital. A decrease suggests a potential need for improved capital utilization.

The decrease in ROIC suggests that ITC's ability to generate returns on its invested capital has slightly reduced. This may be a concern as investors often look for companies that efficiently use their capital to generate returns. ITC should investigate the factors contributing to this decline and take corrective actions.

 

Return on Capital Employed (ROCE):

ROCE is a profitability ratio that measures the efficiency of a company in generating profits from all the capital employed, including equity and long-term debt. It is calculated by dividing Earnings Before Interest and Taxes (EBIT) by Capital Employed.

The increase in ROCE from 18% in 2022 to 21% in 2023 suggests that ITC has improved its profitability in the total capital employed. This could result from increased revenue, better cost management, or improved operational efficiency.

A rising ROCE can still have confidence in investors, as ITC is growing and becoming more profitable of the overall capital invested. While a higher ROCE is generally positive, investors should also consider the risk profile associated with the increase. A significant rise in ROCE without proper risk management could cause concern.

Use of financial metrics: VBM uses a variety of financial metrics to measure and track value creation, such as economic value added (EVA), discounted cash flow (DCF), and return on invested capital (ROIC).

 MVA- Market Value added

Market Value Added (MVA) measures the value a company creates for its shareholders. It is calculated by subtracting the cost of capital from the company's economic value added (EVA). EVA is a measure of a company's profitability that considers the cost of capital.

2022 Analysis:

MVA ($204,668.06):

A positive MVA of $204,668.06 in 2022 implies that ITC has created value for its investors. The market values the company's equity and debt more than the capital employed, indicating that shareholders and creditors have seen a positive return on their investments.

The significant positive MVA suggests that ITC's market value of equity substantially impacts the overall value creation. This could be due to strong financial performance, favorable market conditions, or investor confidence in the company's prospects.

2023 Analysis:

MVA ($318,179.41):

The increase in MVA to $318,179.41 in 2023 indicates continued value creation for ITC. The company has experienced growth in the market value of its equity and possibly an increase in the book value of debt, contributing to a higher MVA.

The substantial rise in MVA from 2022 to 2023 suggests that ITC has successfully leveraged its capital more effectively, and the market perceives the company as having even greater value. This could be due to improved financial performance, successful business strategies, or positive market sentiment.

Overall Trend:

The positive trend in MVA from 2022 to 2023 implies that ITC has successfully deployed its capital to generate value over time. Investors and stakeholders may view this positively, indicating the company's ability to grow its market value and attract more investment.

 

FGV

The higher FGV in 2023 (1,94,865.951,94,865.95) implies a further increase in the market's expected growth for ITC. When subtracted from the current value of operations, the market value of equity and book value of debt results in a positive value, indicating perceived growth potential.

The significant rise in FGV from 2022 to 2023 suggests that ITC's growth prospects have strengthened. This could be due to improved operational performance, strategic initiatives, or positive market sentiment.

Comparison with MVA:

It's interesting to compare FGV with Market Value Added (MVA). While MVA focuses on the difference between market value and capital employed, FGV specifically assesses growth potential by considering the difference between market value and the current value of operations.

Both positive MVA and FGV values for both years suggest that ITC is creating value and has growth potential according to market perceptions.

TSR

Positive TSR (54.94%):

A TSR of 54.94% for ITC in 2023 indicates a positive return for shareholders. This return combines capital gains (increase in stock price) and dividends received over the year.

The increase in the average stock price from $247.59 to $379.51 contributes significantly to the positive TSR, suggesting that shareholders have benefited from the appreciation of the company's stock.

Contribution of Dividends:

The dividends of $4.10 per share also contribute to the TSR. Shareholders not only gained from the increase in the stock price but also received cash returns in the form of dividends, adding to the overall return.

Investor Satisfaction:

A positive TSR is generally an indicator of shareholder satisfaction, as it reflects a profitable investment. ITC has delivered value to its investors, combining capital appreciation and dividend income.

Wealth Added Index (WAI):

The Wealth Added Index (WAI) of $30,616.85 indicates the amount of wealth added to the shareholders of ITC in 2023. This positive metric suggests that the company has generated significant shareholder value.

Contribution of TSR and Cost of Equity:

The formula incorporates the Total Shareholder Return (TSR) and the Cost of Equity. The TSR of 54.94% represents the total return to shareholders, while the 10% Cost of Equity reflects the expected return based on the risk associated with the company's equity.

The positive difference between TSR and the Cost of Equity (44.94%) indicates that ITC has outperformed the expected return, contributing to the positive WAI.

Impact of Opening Market Cap:

The WAI is then multiplied by the Opening Market Cap of $68,007.70. This reflects the scale of the wealth generated, providing an absolute measure of the value created for shareholders.

Comparison with Cost of Equity:

The positive WAI suggests that the company has exceeded the expected return implied by the Cost of Equity. This is generally considered a positive outcome for shareholders, indicating that the company has generated value beyond what investors might have anticipated.

Drivers of ITC:

ROE (Return on Equity):

ITC's share price has increased from 273.95 in 2022 to 329.55 in 2023. This represents a growth of 20.4%. There are a few possible explanations for this growth. One possibility is that ITC's financial performance has improved in 2023. This could be due to increased sales, lower costs, or improved profitability.

Another possibility is that investors are optimistic about ITC's prospects. This could be due to factors such as the company's strong brand recognition, diversified business portfolio, or potential to benefit from economic growth in India.

Return on Assets (ROA):

Interpretation: ROA has increased from 18.90% in 2022 to 20.35% in 2023. This ratio measures how efficiently ITC is using its assets to generate profit. The increase indicates improved efficiency in utilizing assets for profitability. A higher ROA means that ITC effectively utilizes its assets to generate profits. This efficiency benefits the company as it implies better management of its resources.

 

Asset Turnover Ratio:

Interpretation: The asset turnover ratio has slightly decreased from 0.84 in 2022 to 0.82 in 2023. This ratio assesses how efficiently the company is generating revenue from its assets. A decrease suggests a potential area for improvement in asset utilization.

While a decrease in asset turnover may suggest a slight decline in efficiency, it's crucial to understand the nature of the business. For ITC, which operates in diverse segments like FMCG, hotels, paperboards, and agri-business, the impact might vary across these segments.

 

Current Ratio:

Interpretation: The current ratio has improved from 2.81 in 2022 to 2.89 in 2023. This ratio reflects the company's short-term liquidity and ability to cover its current liabilities with existing assets. The increase indicates enhanced liquidity.

The improved current ratio suggests that ITC is better positioned to meet its short-term obligations. This is essential for daily operations and indicates a favorable liquidity position, reducing the risk of default on short-term liabilities.

 

Receivables Turnover:

Interpretation: Receivables turnover has decreased from 26.49 in 2022 to 23.76 in 2023. This ratio measures how quickly the company collects payments from customers. A lower ratio suggests ITC took more time to collect receivables in 2023.

A lower receivables turnover implies that ITC took more time to collect customer payments. This could impact cash flow and working capital management. A detailed analysis of the reasons behind this change is necessary to identify potential areas for improvement.

 

Earnings Per Share (EPS):

Interpretation: EPS has increased from 11.71 in 2022 to 14.02 in 2023. EPS represents the earnings attributable to each outstanding share. The increase is positive for shareholders, indicating higher payments per share.

The increase in EPS is positive for shareholders, as it indicates higher profitability on a per-share basis. This can contribute to a positive perception of the company's financial health and potentially attract more investors.

Price to Book (P/B) Ratio:

The P/B ratio reflects the market's valuation of a company's assets relative to its book value. An increase in the P/B ratio, from 4.91 in 2022 to 6.81 in 2023, indicates that the market is willing to pay a higher multiple for ITC's book value. Investors may interpret this as a sign of confidence in the company's future growth prospects or its ability to generate value from its assets.

A P/B ratio above 1 suggests that the market values the company above its accounting value.

A ratio below 1 might indicate that the market values the company lower than its book value, which could be considered undervalued.

 

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization):

EBITDA measures a company's operating performance and profitability, excluding interest, taxes, and non-cash expenses.

An increase in EBITDA, from 21,572.88 in 2022 to 25,651.26 in 2023, signifies improved operating performance and higher earnings generated from core business operations.

Investors often use EBITDA as a critical indicator of a company's ability to generate cash flow before accounting for financial and tax considerations.

A rising EBITDA may be viewed positively, indicating potential for increased cash flow and financial flexibility.