Tobacco giant ITC’s proposal to demerge its hotels business was never exactly a potential game-changer, given that hotels account for 3 per cent of segment EBITDA and about 4 per cent of of consolidated net sales (FY23). But the move to unlock value by demerging and listing the hotel business seems to have triggered about 7 per cent correction in the ITC stock in the last two days — that is an erosion of about Rs 40,000 crore investor wealth (market capitalisation). ‘
‘Buy the rumour, sell the news’ is an old market adage. It is relevant here because many traders focus on the time leading up to the news or immediately after, when the market is still reacting to the news. However, here are five fundamental reasons why the stock fell.
#1 Falling short of expectations
Though the ITC management has never hinted at any clear structure for the demerger earlier, it appears ITC investors were expecting a full vertical demerger wherein the exact ITC shareholding pattern will be replicated in the demerged hotels business. The ITC board, however, accorded in-principle approval for about 40 per cent stake for ITC in the new entity and the rest for ITC’s shareholders, proportionate to their shareholding. So the hotels business will remain an associate company of ITC, and the separation is not full. While there is value unlocking, it is not 100 per cent as in the case of a full vertical demerger.
#2 Investor exuberance
businessline, on May 29 was the first to report that demerging hotels business is back on ITC’s table. The m-cap of ITC at that time was Rs 5.5 lakh crore, and this shot up to Rs 6.1 lakh crore by July 20. Investor exuberance over potential value unlocking may have contributed to the over Rs 50,000 crore m-cap rise during this period. With the demerger contours now out, this exuberance is being tempered.
#3 Holdco discount angle
Using 7-10 times price/sales benchmark, ITC’s hotels business at ₹2,585 crore annual revenue could be ascribed an m-cap of ₹18,000-25,800 crore. With ITC holding 40 per cent in the hotels entity, ITC’s shareholding in the hotels business could be subjected to a ‘holdco’ discount. While the hotels business’ valuation comprises less than 5 per cent of ITC’s overall value (m-cap of Rs 5.68 lakh crore now), the holdco discount factor is seen as an issue by investors. The holdco discount for such a small business in the overall ITC scheme of things is insignificant. However, it appears to be sentimentally negative for the ITC stock at the moment.
#4 Stock supply overhang
London-headquartered British American Tobacco (BAT) holds over 29 per cent in ITC. BAT will end up with a good holding in the new hotels entity. If the multi-category consumer goods giant (BAT) has no or little interest in a hospitality stock, investors fear this could create a supply-overhang on the new stock. At the same time, the hotels company could get strategic investors who are more aligned with the hospitality business vision.
#5 Stock correction due
In October 2020, the ITC stock was priced at Rs 160-170. Over the next three years, the stock jumped nearly three-fold to hit Rs 499. The quantum of stock price appreciation had outpaced earnings growth. For instance, ITC’s consolidated EPS in FY21 was Rs 10.70, and the same for FY23 is Rs 15.50, which is a 45 per cent growth. Clearly, the price to earnings multiple expansion from 15.9 times (based on FY21 earnings) to 32 times (based on FY23 earnings) was the main driver of share price appreciation, as compared to earnings growth.