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Stock to buy today: This ‘under-appreciated’ stock is D-Street’s newest discovery

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NEW DELHI: This stock has underperformed the BSE barometer in six of last seven years, and its price stands nearly where it was at in 2012.

The stock is finally drawing attention. Most analysts said the time-wise correction on the counter is nearing an end. Some of them project 60-100 per cent upside in the stock in 12-24 months.

Known mainly for its cigarettes, analysts said the FMCG division of this diversified company has possibly been one of the most under-appreciated businesses in the Indian consumer space in recent times. You guessed it right; the stock is ITC.

Big Numbers

One estimate put forward by JM Financial pegged FY30 Ebitda of ITC’s FMCG business at a level higher than the combined FY20 Ebitda of Nestle India, Britannia and Tata Consumer.

“In 10 years, the FMCG business would alone justify the company’s prevailing market value,” the brokerage said, adding that the addressable opportunity for this company at this moment is $22 billion, which is larger than peer HUL’s markets and more than 3 times that of Nestle India’s.

On Monday, September 28, the widely-tracked stock had 18 ‘buy’, 9 ‘outperform’ and 6 ‘hold’ calls. The stock, which is down 28 per cent in 2020 against Sensex’s 8 per cent fall, had no ‘sell’ calls.

Why so bullish?

The company has withstood repeated tax hikes on tobacco products and successfully diversified its FMCG portfolio, which is yielding results now, said analysts.

“Profitability is low at present, but we reckon with the investment phase largely over and profits and cash generation would get much bigger from here on,” JM Financial said.

Elara Capital said cigarettes are cash-cow for ITC with a strong moat. “This business enables the company to have consistent cash flow, powering its food business to chew a mouthful of initiatives,” the brokerage said, adding that six of the company’s 11 FMCG brands are still in the incubation period.

“ITC is emerging as a foods company, which is comparable more with Nestle than HUL. In our deep dive analysis into ITC’s foods business, we concluded that it is on the cusp of a take-off, both in terms of top-line and margins,” it said.


Q1 Earnings


FMCG giant ITC reported a 26.18 per cent year-on-year (YoY) drop in profit at Rs 2,342.76 crore for June quarter against Rs 3,173.94 crore reported for the same quarter last year. Revenue from operations, the company said, dipped 17.39 per cent to Rs 9,501.75 crore against Rs 11,502.82 crore in the year-ago quarter.

Revenue from cigarette sales stood at Rs 3,853.79 crore while total FMCG revenue, including those of cigarettes, came in at Rs 7,228.36 crore.

The company said the impact of Covid-19 pandemic on the carrying amounts of property, plant and equipment, intangible assets, investments, inventories, trade receivables, etc. was insignificant.

Free cash flow
ITC’s free cash flows (FCF) jumped 30 per cent YoY in FY2020 to Rs 11,700 crore led by a reduction in working capital and lower effective tax rate. In the past six years, ITC’s FCF growth was a healthy 17.7 per cent annually, said Kotak Securities.

FCF/Ebitda for FY2020 stood at highest level in the last many years, at 65.3 per cent.

Besides, return on equity (RoE) for FY20 expanded 60 basis points to 23.3 per cent, even as asset turnover came down. However, return on capital employed for the year declined to 25 per cent from 27 per cent in FY19 due to weak operating profit growth.

Mutual Fund participation missing

Sandip Sabharwal of asksandipsabharwal.com said that at the current market price of Rs 170, and taking into account the 6 per cent dividend that ITC pays and the huge cash flows it generates, it is tough to lose money on this stock at these levels.

The risk-reward is favourable, he said.

Analysts, however, noted that while a lot of analysts recommend the stock, mutual fund portfolios do not really hold ITC. Top 10 of 15 largecap funds do not hold it as a long slump in the stock has ‘frustrated’ them.

The stock was down 16 per cent in 2019 when BSE Sensex rose 14 per cent. In 2017, it rose just 9 per cent against Sensex’s 28 per cent rise. In 2016, it fell 25 per cent against Sensex’s 1.94 per cent rise. In 2015 and 2014 as well, it underperformed the benchmark index

“If there is some positive news on the FMCG business, it could actually create a good move on the counter. I would be more on the buy side at its current price,” Sabharwal said.

Inexpensive valuation

Kotak finds valuation for the stock inexpensive. “ITC has undergone a time correction and de-rating over the past eight years even as EPS and FCF compounded at annual growth rates of 10 per cent and 15 per cent over FY12-20.

“We believe concerns around cigarette taxation in view of stretched government finances and increased focus on ESG-compliant investment are more-than-adequately priced in. The stock offers a good combination of inexpensive valuations at 13 times September FY22 PE, healthy dividend yield of 6 per cent and promises solid long-term growth in FMCG,” it said.

Kotak’s fair value of Rs 260 on the stock suggests a 50 per cent potential upside.

JM Financial has an even bigger target of Rs 275, which suggests nearly 60 per cent upside.

“At ITC’s FY30-based valuation (discounted to present value), FMCG alone would justify half of present market value. This implies that the cigarette business, which generates 85 per cent of profit is currently valued at just 4-5 times PE,” the brokerage said.

Centrum has a price target of Rs 351, projecting a 100 per cent upside in two years. It noted that ITC commands a market leadership position with 75 per cent market share and best-in-class profitability and return ratios, and thus, it has assigned a 10 per cent premium to its cigarette business valuation over peers VST Industries and Godfrey Phillips.

It said ITC’s improving profitability profile is still lower than Britannia’s, and thus it has assigned a 20 per cent discount to its FMCG business over Britannia’s three-year average EV/sales.

The brokerage finds a strong moat in ITC’s agri-business, given its connection to the hinterland through e-choupals and strong affinity among the farmer community. Centrum gave a higher premium to ITC’s paperboard divisions and in-line valuations to its hotel business to arrive at its target.





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US banks could cut 200,000 jobs over next decade, top analyst says

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US banks stand to shed 200,000 jobs, or 10 per cent of employees, over the next decade as they manoeuvre to increase profitability in the face of changing customer behaviour, according to a banking analyst. 

“This will be the biggest reduction in US bank headcount in history,” Wells Fargo analyst Mike Mayo told the Financial Times. If his forecast bears out, this year would mark an inflection point for the US banking sector, where the number of jobs has remained roughly flat at 2m for the past decade.

The jobs most at risk are those in branches and call centres as banks prune their sprawling networks to match the new realities of post-pandemic banking, Mayo’s report found. That is consistent with Department of Labor statistics that predict a 15 per cent decline in bank teller jobs over the next decade.

Historically, lay-offs, particularly for lower-paying jobs, have been a contentious issue for the banking industry, which is often held up by progressive politicians as an example of a wealthy industry prioritising profits over people.

But the threat of technology companies and non-bank lenders chipping away at the business of payments and lending, which have traditionally been dominated by banks, has intensified over the past year, making job cuts necessary, Mayo said.

“Banks must become more productive to remain relevant. And that means more computers and less people,” he said.

Most of the reductions can be achieved through attrition over the next 10 years rather than cuts, reducing the risk of a backlash, Mayo said.

The new research, reported first by the FT, comes on the heels of disappointing jobs data that showed the US economy added just 266,000 jobs last month, sharply missing estimates of 1m. Structural elements of unemployment like accelerated automation that took place during the pandemic could pose stronger than anticipated headwinds to a recovery in the labour, economic officials said following the report. 

Pandemic activity pushed headcount up roughly 2 per cent last year as banks hired staff to meet the sudden demand for labour-intensive mortgages and government-backed small-business loans. But that trend is likely to be reversed in the near-term as lenders refocus on efficiency to compete more effectively with technology companies that increased their share of business during the health crisis. 

Increased competition from unregulated companies such as PayPal and Amazon entering financial services was one of the principal concerns JPMorgan Chase chief executive Jamie Dimon outlined in his annual letter to shareholders last month. 

Mayo estimates that banks currently represent just a third of the overall financing market.

“Digitisation accelerated and that played to the strength of some fintech and other tech providers,” Mayo said. 

Many of the bank branches that were closed during the pandemic will probably stay that way, and even those that remain open are likely to be more lightly staffed as branches become more focused on providing advice than facilitating transactions. A large amount of back-office roles also stand to be automated but those numbers are harder to quantify, the report said. 

Mayo said his team 20 years ago was twice as large and responsible for half as much. Doing more with less was the new norm across the industry.

“If I was giving advice to my kids, I’d say you probably don’t want to go into the financial industry,” Mayo said, adding that technology and customer or client-facing roles are probably the only areas that will see growth. “It’s likely to be a shrinking industry.”



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Inflation wild card unsettles markets

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Regime changes usually take a while to fully register among investors. The big talking point in markets at the moment surrounds the potential return of a more troublesome level of consumer price inflation and what protective action investors should take.

The underlying trend of inflation matters a great deal for financial markets and investor returns. The rise in both equity and bond prices in recent decades has occurred during a long period of subsiding inflation pressure and from recent efforts by central banks to arrest disinflationary shocks since the financial crisis. 

A year after the global economy abruptly shut down, activity is duly picking up speed. The logical outcome has been a surge in readings of inflation and this week, a measure of US core prices recorded its largest annual gain since 1996, running at a pace of 3 per cent*.

Core readings exclude food and energy prices and are deemed a smoother gauge of underlying inflation pressure, a point that many people outside finance find baffling when budgeting the cost of groceries and petrol.

So the significant jump in the core measure, and even accounting for the base effect of the pandemic’s brief deflationary shock a year ago, has understandably generated plenty of noise.

This will remain loud in the months ahead as activity recovers from lockdowns with a hefty tailwind of fiscal stimulus working its way through the broad economy.

But muddying the waters for investors is that the outlook for inflation is still difficult to judge at this stage.

“There is so much dislocation in the economy from the reopening and base effects from a year ago that it will take at least six to 12 months before we get a clear view of the underlying inflation trend,” said Jason Bloom, head of fixed income and alternatives ETF strategies at Invesco.

Investors who are now worried about an inflation shock face a dilemma. Some assets seen as traditional hedges against such a risk, like inflation-protected bonds and commodities, have already risen appreciably. Effectively a period of inflation running hot has been priced in to some degree.

And history does provide a cautionary note for those moving late to buy expensive inflation protection.

Past inflationary alarms, as economies recovered in the wake of the dotcom bust in the early 2000s and the financial crisis of 2008, proved false dawns. After a mercifully brief pandemic recession, the powerful and well entrenched disinflationary trends of ageing populations and falling costs associated with technological innovation are by no means in retreat.

For such reasons, a number of investors and the US Federal Reserve expect inflationary pressure this year will prove “transitory”. But stacked against deflationary forces is the immense scale of the monetary and fiscal stimulus of the past year.

The effects of monetary and fiscal stimulus means “inflation may settle into a pace of 2.5 per cent (annualised) and that would be different from the average of 1.5 per cent before the pandemic”, said Jason Pride, chief investment officer of private wealth at Glenmede Investment Management. “Inflation will be higher. At a dangerous level? No.”

In an environment of firmer growth and moderate inflation pressure, equities will benefit, led by companies that have earnings more influenced by the economic cycle. Investors also will seek companies that have the ability to pass on higher prices to customers in the near term and offset a squeeze on profit margins.

Still, a troublesome period of elevated inflation cannot be easily dismissed. The “transitory” argument could be challenged if economic growth continues to run hot into next year, accompanied by a trend of higher wages from companies finding it hard to attract workers.

Before reaching that point, expected inflation priced into the bond market may well push past the peaks of the past two decades and enter uncharted territory in the US and also for other developed markets in the UK and Europe.

Bond market forecasts of future inflation pressure over the next five to 10 years have already risen sharply in recent months. But the rebound is from a low level and for now, expected inflation is not far beyond the Fed’s long-term target of 2 per cent.

“It is the change in inflation expectations that drives asset returns,” said Nicholas Johnson, portfolio manager of commodities at Pimco. Assessing almost 50 years of data, a portfolio holding equities and bonds underperforms during bouts of elevated inflation, while real assets including inflation-linked bonds and commodities prosper, according to the asset manager.

“Most investors have not experienced a period where inflation surprised to the upside,” added Johnson. Clients are asking more questions about insulating their portfolios, but their present exposure to commodities and other assets show that in broad terms investors are “not paying much of an inflation premium”.

That can change and the prospect of inflation regime change remains a wild card for investors.

michael.mackenzie@ft.com

*The value of core inflation has been changed since first publication.



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How traders might exploit quantum computing

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If you had a sports almanac from the future as did Biff Tannen, the brutish bully of the time-travelling Back to the Future movie trilogy, how might you be inclined to take advantage of the foresight buried within it?

The obvious temptation would be to place sure bets in the market that make you rich. In Biff’s case, the wealth is then used to change the world into a dystopian reality in which he himself exists as “America’s greatest living hero”.

That sort of thing used to be considered fiction. But the dawn of so-called “supremacy” of quantum computing over conventional technology raises the possibility that one day soon someone might be able to effectively see into the future.

This is because quantum computers, when they become fully capable, are likely to be uniquely good at crunching probability scenarios. They are based on the mysterious world of quantum physics. Quantum bits or qubits are the basic units of information in quantum computers. Unlike the binary bits of traditional computing, which must be either zero or one, qubits can be both at the same time.

This gives quantum computers super powers that will allow them to solve probability-based tasks that would previously have been impossibly hard for conventional counterparts in realistic timeframes. If the problem at hand was a game of football, adding quantum computers to the mix is like allowing footballers to use their hands to get the ball into the net, say quantum experts.

It’s a prospect that poses an entire new set of challenges for market regulators and participants. If super quantum computers really can help institutions see into the future, the information advantage will be unprecedented.

It might also represent an entirely new type of front-running and market manipulation risk, one that regulators can’t necessarily even identify unless they too have a quantum computer at hand.

In Back to the Future, the almanac gave Biff a 60-year insight advantage over everyone else in his home 1955 timeline. With quantum computers, the edge might only be nanoseconds. But in the fast and furious world of high-frequency trading, that could be enough to sweep up.

The reassuring news — at least for now — is that we’re still at least five years away from quantum computers being powerful enough to compete with existing supercomputers on much simpler problems. Prediction might not even be their initial forte.

Goldman Sachs research recently noted, as and when quantum computers are rolled out, they are far more likely to be deployed on crunching options pricing conundrums or running Monte Carlo simulations that value existing portfolios than they are on predicting future movements of asset classes.

According to Tristan Fletcher, of artificial intelligence-forecasting start-up ChAI, that’s because prediction is ultimately about solving a very specific, deep problem by understanding the nuances of the data that matters.

“We are already at the limits of what any system that isn’t actually listening to Opec meetings and five-year plans is capable of,” he said. It’s not the complexity of the calculation that is the issue as much as the breadth of the data sample at hand. That means prediction wouldn’t necessarily get more accurate with quantum power.

The appeal to focus on “brute-force” problems such as optimising portfolio analysis or cracking cryptographic problems such as those that underpin bitcoin, the cryptocurrency, is far greater.

But this poses its own problems. If cryptographic systems can be broken, exceptionally sensitive data held across the financial system could be exposed and taken advantage of in unfair and market manipulative ways.

Rather than being able to better predict the market, the true pay off in the arms race might lie in achieving quantum-level encryption-breaking capability and using it subtly to seize the information that can get a trader ahead. Experts say the chances someone is already up to this, however, are low. If quantum supremacy had been achieved, the news of it would leak pretty quickly.

“We don’t know what we don’t know,” said Jan Goetz, chief executive of IQM, a quantum computing builder. “But generally the community is very small so everyone knows what’s going on. The status quo is clear.”

Nonetheless, the financial sector seems to be waking up to this quantum computing issue. Many banks and institutions are introducing teams to think exclusively about how quantum computing will affect their business. How far ahead they are on making their systems quantum secure is harder to say. It’s a secretive issue. For now, most agree, the threat level is low, not least because — as the hacking of the Colonial pipeline shows — system security is low enough to ensure far cheaper and simpler ways to hijack digital systems.

izabella.kaminska@ft.com



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