Running a business that the government loves to hate
Understanding ITC's cash cow and other businesses
Click here to join FutureX Learning community on Whatsapp.
Can a business harm customers and still win?
Which business do you think has a product that kills the user, the product markets that it's harmful, but consistently, year after year, the user comes back?
No surprises? It's cigarettes 🚬
About ITC, the country's largest cigarette manufacturer
ITC has a business that the government loves to hate. Every year's budget levies some additional cess or tax on the firm. The firm passes through most of it via a price hike. Analysts get spooked, earnings estimates get revised downwards, but the company marches on - only to see the same thing repeated next year.
Some stats about the cigarettes segment now:
- ITC accounts for 85% market share in the legal cigarettes market in the country.
- Roughly 10% of the world’s tobacco smokers live in India, representing the second largest group of smokers in the world after China.
- Cigarette taxes in India are among the highest in the world - 64% excise duty, 28% GST, and 5% cess.
- But the high price doesn’t deter the user - The average cigarette smoker spent close to 1200 INR/month on cigarettes in FY17, up from 670 INR less than a decade ago.
- Cigarette manufacturing is a highly lucrative business financially, ITC had a return on invested capital of over 400% and operating margin of 70% in its cigarettes segment in FY20.
💰 Cigarettes is essentially the cash cow for ITC.
ITC generates more than 80% of the operating income from cigarettes, and this helps the firm nurture its star -"other FMCG". ITC has a house of notable FMCG brands including Aashirwad (#1 in branded flour), Sunfeast (#1 in cream biscuits), Bingo (#2 in Chips) and Yippee (#2 in Noodles). Having the backing of the cigarettes business to fund the FMCG business has meant that the firm could make low margins, even lose money as they gained share in the key segments they operated in. And it has done just that, taken hits on margin consistently as it grows the business and builds brands.
❓Does this strategy of using the backing of the cash cow to fund other businesses remind you of any other company? Reliance Industries uses the cash generated from its petrochemicals business to fund all its other business – Telecom, Retail, E-commerce and the whole suite of other businesses it is planning to build (Education, Content, Music etc). Petchem generates close to half of the operating income for the firm and all the cash from this segment has allowed it to grow from virtually no presence in 2016 to the #1 telecom player in the country in less than 4 years.
Great deep dive on ITC business and fundamentals:
https://medium.com/@agnanidivyansh/itc-e90752a078a6
Other interesting reads:
https://www.gsninvest.com/post/of-cash-cows-and-stars-itc-reliance