ITC hotel biz demerger allays capital allocation concerns, say analysts

Some investors may have preferred a vertical split (100 per cent direct). This move will not likely have a big implication for ITC's share price, wrote analysts at Jefferies in a note

ITC’s move to demerge the hotel business into a new entity, ITC Hotels Ltd, is a step in the right direction and will allay investor’s concerns on the company’s capital allocation strategy in the medium-to-long term, said analysts at Morgan Stanley in a note.

According to the company, the board of directors has approved in principle the demerger of the hotels business, wherein ITC will hold a 40 per cent stake in the new entity, and the remaining 60 per cent will be held directly by shareholders. The scheme of arrangement shall be placed for approval of the Board at its next meeting to be convened on 14th August 2023.

“We view demerger of the hotels business as a positive because it should allay concerns about capital allocation and use of cigarette business cashflows to develop other businesses. To note, the company had flagged its decision to explore alternate structures for the hotels business in its FY20 annual report, which was subsequently delayed by the pandemic,” wrote Sheela Rathi, Archana Menon and Shravan Vohra of Morgan Stanley in a coauthored note on Monday.

The brokerage maintained its 'overweight' rating on the stock with a price target of Rs 474. Post the announcement on Monday, the stock ended 3.9 per cent lower on the BSE at Rs 470.9, after hitting an intra-day low of Rs 468 and an intra-day high of Rs 499.6 – before the company unveiled its plans.

“We currently value the hotels business at Rs 174 billion (Rs 14/share, 3 per cent of our price target), implying a valuation of 5.6x F25e EV/sales and 19x F25e EV/EBITDA, vs. 8x and 24x, respectively, for Indian Hotels,” analysts at Morgan Stanley wrote.

Those at Jefferies, on the other hand, believe that the sharp fall in the stock price from the day's high on Monday was mostly on account of a slight disappointment as regards the scheme of arrangement. They, however, still maintain a buy rating on the stock with a price target of Rs 530.

“Some investors may have preferred a vertical split (100 per cent direct). This move will not likely have a big implication for ITC's share price and is not a precursor to other businesses going the same way. We also see a case for ITC to levy a brand royalty to the hotel business. Once listed, we see a risk there could potentially be some supply pressure from existing shareholders in the case of ITC Hotels, especially from shareholders like BAT. We also note that most analysts currently do not apply a hold-co discount, which could potentially be the case once ITC Hotels is separately listed,” wrote Vivek Maheshwari, Kunal Shah and Jithin John of Jefferies in note post the development on Monday.

From the core cigarette business perspective, analysts at Emkay Global expect rational tax hikes ahead, given higher share of the ad-valorem component leading to build-up of volumes, which along with improving mix would aid a high-single-digit EBIT growth. In a recent note, they too maintained a 'buy' rating on the stock with a price target of Rs 525.

"In non-cigarette operations, we continue to see profitable growth and improving return profile, where segments are self-sufficient to address their growth needs. Amid the enhanced demand setting in food & beverages (F&B), agri export and paper, execution is key. We continue to see ahead-of-time capex as a business moat, which enhances the company’s structural prospects. Value unlocking in Hotels operations remains a near-term catalyst,” wrote Nitin Gupta and Soumya Jain of Emkay in a July 15 coauthored note.