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Our positive stance on ITC relies on strong execution across business segments for which we remain upbeat. We maintain BUY on ITC with Jun-24E SoTP-based TP of Rs525/sh. Mgmt has been addressing concerns on capital allocation, where Hotels business unlocking is part of the arrangement. While value unlocking owing to demerger of the Hotels business is unlikely to be material, we see improvement in ITC’s returns profile, post demerger of hotel operations. Key clarifications with regard to the demerger: a) retention of 40% stake in the new entity is to provide stability and sustain cross-business synergies; b) there will be a royalty arrangement with the new entity for usage of ITC brands; c) scheme to be tax-neutral, but entail stamp-duty charges; d) call for further dilution in stake rests with the Board, which will act as per the existing circumstances.

Asset right strategy to stay for Hotels; royalty for brand usage on the cards

Management noted that the new Hotel entity will look to further explore opportunities in the promising hospitality industry. ITC’s intent of continuing with 40% stake in the new entity is to facilitate stake-holder comfort. Additionally, there is no intent to expand its holding in the new entity by acquiring stake sold by any shareholder. Given that the asset right strategy is in place for hotel operations, Management does not see the need for any large capex in the business ahead (should be equal to depreciation). If a need does arise (such as an opportunity to acquire trophy property), the new Hotel entity will have the choice of both, the debt and the equity routes, for raising capital. Hotel business’s balance sheet is likely to be strong, given its zero debt. On usage of ITC brands, Company will impose royalty, the rate of which is unlikely to be material. ITC looks to sustain business synergies on arm’s length basis.

Demerger unlikely to have any tax impact, but entails stamp duty charges

The demerger scheme is likely to be tax-neutral for all stakeholders — ITC, ITC Hotels and shareholders — as the company sees itself adhering to the conditions specified in Section 2(19AA) of the Income Tax Act. However, ownership change of properties will entail stampduty charges. Management noted that the stamp-duty charges across States is nominal for mergers and demergers and, as such, will not entail material charges. As both the entities will be based in West Bengal and the West-Bengal NCLT will approve the scheme, the company will require paying royalty of 0.5% on 60% of the market value.

Demerger value unlocking not material, though will help improve return ratios

In our SOTP valuation, we ascribe 3% to Hotels business (valued at Rs18/sh), where value unlocking is unlikely to be material for shareholders. But given the asset transfers, ITC’s returns profile would see sharp expansion. We await necessary approvals, before effecting the transaction in our SOTP value. We retain BUY with Jun-24E SOTP-based TP of Rs525. We value Cigarettes business at 23x PER (Rs283/sh; ~54% of TP) and ‘Other FMCG’ at 6x Jun-25E sales (Rs120/sh; ~23% of TP).

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