ITC’s best strategy: The Indian conglomerate is in no hurry to win

British American Tobacco Plc, the single-largest owner, has always wanted ITC Ltd., as the firm is now known, to focus on cigarettes, and funnel the profit back to its own shareholders. The local management successfully fought to keep the proceeds of addiction at home with the backing of state-run financial institutions, which together control roughly the same stake as BAT’s 29%. As a result of those past battles, ITC is today into everything from hotels and wheat flour to soap, paper and information technology.

Several of those forays have been unimpressive so far, though that is beginning to change. The stock has returned nearly 100% in the past 16 months, the best performer on the benchmark Nifty 50 Index. Meanwhile, other Indian conglomerates have stumbled. The tycoon Gautam Adani’s debt-laden infrastructure empire has soared and crashed, while rival Mukesh Ambani’s Reliance Industries Ltd. has disappointed investors despite aggressive expansion in everything from retail and telecom to green energy.

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By contrast, the unhurried pace of ITC, not controlled by any business family, has been reassuring. Rather than launch a fresh empire-building spree, Sanjiv Puri, who rose through the ranks to become chairman four years ago, has focused on long-term sustainability of the existing portfolio. A year before Covid-19, ITC sold its menswear brand John Players to Ambani’s Reliance Retail, and started shuttering Wills Lifestyle, a premium apparel business that never had a chance against e-commerce. The question now is about other non-tobacco consumer goods in Puri’s stable, such as wheat flour, biscuits, noodles, dairy and beverages. Making food more profitable is ITC’s short-term challenge. The trickier part is to build a low-carbon supply chain around it, connecting tens of millions of farmers with hundreds of millions of consumers.

The country’s eighth-largest publicly traded firm has a market value of $60 billion; it’s sitting on nearly $2 billion of net cash. The 93% of profit ITC returned to investors in the last financial year — after steadying its pandemic-ravaged hospitality division — is a welcome relief from the blistering growth family-run Indian businesses have pursued, without much to show for their efforts.

ITC’s sweet spot won't last forever. Even in a nation of 1.4 billion where one in four adults still uses tobacco, the smoking habit must ultimately fade into the sunset. Right now, it’s a great franchise because ITC controls nearly 80% of the cigarette market. In the nine months through December, the unit’s revenue grew 22%, three times faster than ITC’s own historical average. That’s because of surprisingly stable taxation over the past five years. With illegally imported sticks losing their price advantage over tax-paid cigarettes, profitability has gone through the roof. On an annualized basis, return on depreciated cigarette assets is approaching a staggering 240%, three times the level two decades ago.

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A responsible public health approach would require a quid pro quo. The state would ask ITC to start investing in noncombustible products such as heat-not-burn sticks and Swedish snus, helping to counter the sway of bidi — cheap tobacco rolled in coarse leaves — and crushed betel nuts mixed with nicotine, or gutka, an addiction that leads to mouth cancer.

ITC has the technology, but the onus of pushing for harm reduction is on the government. New Delhi’s current policy is the exact opposite: It has imposed a complete ban on e-cigarettes out of a fear that they would become a gateway device for the youth. Those concerns exist everywhere. Even the US Food and Drug Administration has faced criticism for not doing enough to curb flavored nicotine vapors. But in India, traditional products are a far bigger health risk than new technology. The lobby behind chewable tobacco is formidable. Bidi, the poor man’s preferred option for nicotine delivery, is sparsely taxed because it supports 4 million jobs in rural and semi-urban areas.

Cigarettes give ITC unmatched access to general trade, or the network of millions of mom-and-pop stores that reach buyers across the country’s vast geography. Now that commodity-price inflation following Russia’s war in Ukraine is easing, consumer-goods makers are optimistic of a revival, particularly in rural areas where demand slowdown has been both brutal and protracted. ITC can stay around and compete, provided it can lift the unit’s 9% return on assets. With less mature brands, ITC is lagging behind multinationals like Unilever Plc and may soon have to face new competition in general trade from Ambani. Still, staples provide a natural outlet for its other big bet: agriculture.

One way to meet niche consumer demand for gluten-rich grain is to select it from the wheat crop ITC buys. A more efficient alternative is to help farmers’ collectives grow higher-gluten varieties in areas where it makes the most sense. From quick soil-test results on mobile phones to hyperlocal weather forecasts, pest predictions, and crop-monitoring by drones, Puri is building a super-app for farmers with climate at its core. The company is already at the receiving end of extreme weather: After a heat wave damaged last year’s wheat crop, India banned exports, hurting ITC’s revenue. Cutting emissions in the food supply chain and protecting farmers from global warming are business imperatives.

Once the new spice processing factory in Guntur, Andhra Pradesh, and the upcoming medicinal nicotine export unit in Mysuru, Karnataka, start paying off, the 24% return on agricultural assets could start to push against the 30% mark. The business is undoubtedly a keeper. So is the paper division. ITC got into cigarette-packaging nearly 100 years ago, and expanded into paperboards in 1979. Puri is now investing in technology that will cut plastic use in smartphone boxes. (Think of it as a paper-pulp egg tray for electronic devices, only sturdier.) After cigarettes, the paper unit already garners the second-highest margins for the conglomerate.

That brings us to hotels. A strong post-pandemic recovery is under way for nearly every player in the Indian hospitality industry. Beyond that, however, an asset-heavy business that has historically struggled to garner even a 5% return doesn’t make sense. ITC's popular restaurant brands will add heft to the cloud-kitchen services it has piloted, while the real estate has its own value. The first 12 hotel buildings anywhere in the world to be certified as net-zero-carbon by the US Green Building Council are ITC properties. Hiving them off into an investment trust might attract interest even from those institutional investors who won’t go anywhere near tobacco companies.

By disallowing new foreign direct investment in tobacco in 2010, India has practically closed the door on a takeover by British American Tobacco. Unless the government has a change of heart, ITC won’t even do a share buyback that could potentially raise BAT’s stake. However, Puri can use the window provided by India’s nationalist tobacco policy to extract the most juice out of the capital he’s allocating to more sustainable businesses — while keeping investors hooked with lavish dividends. With time and money on its side, ITC’s best strategy is to be that Indian conglomerate that’s in no hurry to win.