Is there ‘Real Option Value’ in ITC Limited?

If I had a dollar for every time someone told me to write a post about ITC Limited, I would probably be in the same league today as Musk, Bezos and Buffett.

Interestingly, a month back I came across a fascinating piece titled ‘WACC and Vol’ co-authored by Michael Maubossin.

While every single sell-side analyst in this country along with multiple bloggers have covered the length, breadth and width of the stock, I will try to keep the perspective unique, fresh and hopefully a source of value addition.

Grab a coffee, as I jump in.

“Give me six hours to chop down a tree, and I will spend the first four sharpening the axe.”

Abraham Lincoln

My tryst with the company goes way back to 2011 where I was filling the entrance form for my CA foundation exams and crossed the fancy building on Russell Street which every finance professional in Calcutta dreams of eventually landing up into.

As someone who always had a deep interest in marketing – everything that ITC did (Sunfeast Open, Dark Fantasy, The Mad Angles campaign) kept pushing the bar higher for the mind-space it occupied as a consumer.

If you’ve ever liked playing Logo Quiz on Android or fascinated by brands, ‘Ogilvy on Advertising’ is a must-read.

If you look at any consumer-facing brand that is operating in this country, a bulk of the amount is spent on acquiring users by burning cash in the initial stage. The CAC-LTV conundrum keeps haunting every marketing department.

What is CAC-LTV?

Customer Acquisition Cost / Lifetime Value – How much money is justified to spend on CAC to ensure that the LTV of the customer makes sense. For eg. if I am running an e-commerce platform and I spend 200 rupees to acquire a customer, my belief is that the customer would end up making purchases of 1000+ over it’s lifetime. This will allow me to optimize my spends over a period of time.

Looking at the FMCG space, it is no wonder that most of these new age FMCG brands try their hands to get into the DTC (Direct To Consumer) space. It may seem really fancy that these folks are printing money, but HUL summarized their business models in a simple acronym.

C.R.A.P.

Can’t Realize Any Profit

Read about this in detail here.

After setting this context and reiterating my confirmation bias, let’s try and answer the question we started off with at the start of this post.

Is their ‘Real Option Value’?

In an e-mail sent to Maubossin, Michael was happy to respond and point to the fact that the theory has been in existence for quite some time in the world of finance but the investing community has not embraced it with the conviction it deserves to receive.

So what is ‘Real Option Value’?

I am not going to bore you with a fancy Black-Scholes formula but simply put, you try and value a business as a sum total of it’s existing business (you do a DCF, SOTP, Price to Book etc.) and compute/impute what can be the potential value of a future business (catalyst / commercial rights etc.).

Let’s take Savlon for example to put things into context. In the Q2 commentary, ITC indicated that they are on track to reach the 1000 cr.+ mark in consumer spends for the brand! Would this had been possible without Covid coming in?

Call it being at the right place at the right time or simply put, having the right ‘catalyst’ to create real value, these are precisely one of the many things that can drive option value.

Category Creator

ITC has always been believed to be a category creator.

When packaged atta was launched in this country, the concept did not exist. Today, the category itself has matured prompting multiple regional players to come in where ITC has the lion’s share in the segment.

Engage pocket spray is another classic example.

Today, they plan to do the same with frozen snacks and food (including prawns) – a space that has been quite cluttered and can emerge as a new category which is curated by the company.

Integration and Linkages

While a lot has been talked about integration, linkages and synergies – the devil lies in the details.

In ’07 ITC acquired a company called Technico Agri Sciences that owns ‘Technituber’ technology to make superior grade of potatoes. You can read more about it here and in the annual report.

In ’17 the company started commissioning ICML’s or Integrated Consumer Goods Manufacturing and Logistics facilities to strengthen their distribution and in less than 3 years this has been scaled up to 9 as on September ’20.

This is just a glimpse of the kind of capabilities the company has in terms of its sourcing strength and really creating a competitive advantage for itself in the grander scheme of things.

I have conducted a detailed webinar on the company on Sunday. If you wish to access it, click here.


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About the author

Saket Mehrotra

Number cruncher, avid reader, coffee connoisseur, book store hopper & Metallica fan. An active follower of Sensex since 2009. CA, CS by profession.
Senior Associate - Equities at Tusk Investments. Ex - PMI, ITC.

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