Why ITC's Sunrise Foods deal is positive but unlikely to push up valuation

While the deal offers distribution and sourcing synergies, pressure on dominant cigarette business remains

ITC’s acquisition of Kolkata-based Sunrise Foods — a market leader in eastern India in the spices category — is in line with the cigarette major’s focus on expanding its non-cigarette FMCG business. While the deal value was not revealed, some analysts peg it at around Rs 1,500-2,500 crore. 

Analysts say, the move improves the growth outlook of ITC’s FMCG business, which includes popular brands, such as Aashirvaad, Bingo!, Yippee!, and Sunfeast. While the deal is in the right direction, the dominance of the cigarette business continues, and hence, remains a key concern given the pressure on volumes. Moreover, the deal is not big enough to move the needle on the FMCG business in the short term.

Vishal Gutka, president at PhillipCapital, says: “Though the acquisition of Sunrise is sentimentally positive for ITC’s stock and is in line with the firm’s strong focus on the non-cigarette FMCG business, a sharp increase in the overall profitability and catch-up in valuation (with peers) are unlikely, given the dominance of the cigarette business.” He, however, has a ‘buy’ rating on the stock, mainly due to low valuation.

Positively, even as Sunrise is a sub-scale acquisition given that it will add just 5 per cent to ITC’s FMCG revenues, its operating margin is three times that of the latter’s FMCG business. Its sourcing and distribution synergies also augur well. The estimated deal value, too, is seen as reasonable, at about two times revenue.

 

 

Analysts believe synergies in sourcing and distribution with ITC’s pan-Indian presence will give strong traction, not only to ITC’s spices segment but also its overall non-cigarette FMCG business. Sunrise, too, has strong distribution in eastern India and around 40 per cent spices market share in Bengal, according to Edelweiss Securities. ITC has been undertaking an inorganic expansion of its other-FMCG business since the last four-five years.

Until the cigarette business accounts for a large share of ITC’s revenue (now over 40 per cent) and operating profit (85 per cent), investor sentiment will remain muted. Competitive intensity from players like Godfrey Phillips, and lower cigarette consumption amid the Covid-19 pandemic are the other concerns. 

A survey by Edelweiss Securities reveals almost 80 per cent of the respondents have indicated a sharp fall in their cigarette consumption, and many (over one-third) have stopped smoking. Then, there is a high probability of an increase in tax on cigarettes given the fiscal deficit burden on state and Union governments. These are bad news for the entire cigarette industry.

Analysts say regulatory overhang on the cigarette business and capital misallocation for some of its businesses, such as hotels, has kept ITC’s valuation (14.6 x its FY21 estimated earnings) way lower than those of other FMCG majors (over 35 times). Thus, how the cigarette business pans out and how the company expands its other FMCG segments remain crucial for investors.