ITC Hotels Demerger: Is It Good for Existing and New Shareholders of ITC?

ITC, one of India’s oldest and most diversified companies, has made headlines again with its decision to demerge its hotel business, ITC Hotels, effective January 1, 2025. If you’re wondering what this means for you an an existing or potential investment (considering buying ITC shares for the long term), this blog will declutter the topic for you. We’ll cover two main questions:

1. Is this demerger good news for existing ITC shareholders?
2. Should new investors buy ITC stocks for the next 10-15 years, or are there better alternatives?

But before we dive in, let’s quickly understand what a demerger is.

In simple terms, a demerger is when a company separates one part of its business into a new, independent company. Think of it like splitting a giant pizza into two separate slices, each functioning independently.

ITC’s Hotels Demerger: What’s Happening?

ITC, known for its cigarettes, FMCG products, hotels, and paper business, is demerging its hotel division into a separate company called ITC Hotels Ltd.

Here are the key points:

• The demerger will take effect on January 1, 2025.
• ITC will own 40% of ITC Hotels, and existing ITC shareholders will get 60% of ITC Hotels’ shares.
• For every 10 shares of ITC Ltd one owns, the shareholders wil receive 1 share of ITC Hotels.
• ITC Hotels will be listed on the stock exchanges.

Recently, Sanofi India also had a similar demerger of its ‘pharma business’ and ‘consumer healthcare business.’ Eventually, on 13-Sep-2024, Sanofi Consumer got listed on the stock exchange and existing Sanofi India shareholders got Sanofi Consumer’s shares in appropriate proportions. Read more about it here.

Why Did ITC Decide to Demerge Its Hotels Business?

ITC’s decision to demerge its hotel business into a separate entity, ITC Hotels Ltd, is a strategic move aimed at optimizing growth and enhancing shareholder value. The hotel business, while prestigious and promising, operates quite differently from ITC’s core businesses like FMCG and tobacco.

Let’s break down the four key reasons behind this decision in detail.

1. Unlock Value: Independent Market Valuation for ITC Hotels

The hotel business is a unique segment that requires its own growth strategy and valuation metrics. By demerging, ITC Hotels will now be listed independently on stock exchanges like the NSE and BSE. This allows investors to value ITC Hotels separately, rather than as a small part of ITC’s overall conglomerate structure.

Why is this important?

• Focused Investor Attention: In a diversified company like ITC, the hotel segment often doesn’t get the attention it deserves. Investors may overlook the potential of ITC Hotels when evaluating ITC’s overall business, which is dominated by the cigarette and FMCG segments. By demerging, ITC Hotels can attract investors specifically interested in the hospitality sector.
• Fair Valuation: The hospitality industry has different growth drivers compared to FMCG or tobacco. For example, metrics like RevPAR (Revenue per Available Room), occupancy rates, and average daily rates (ADR) are critical in evaluating hotel businesses. These metrics don’t apply to ITC’s other segments, making it difficult to fairly assess the hotel business within the larger ITC framework.
• Investor Confidence: A separate listing allows ITC Hotels to be judged solely on its performance and growth potential in the hospitality sector. This can lead to better investor confidence and potentially higher valuations if the business performs well.

Example: Think of a student who excels in both math and sports. If the school only recognizes academic achievements, the student’s athletic talent may go unnoticed. But if the student joins a sports academy, their athletic skills can be recognized and rewarded appropriately. Similarly, ITC Hotels can now shine in its own arena.

2. Focus on Core Businesses: Strengthening ITC’s Main Profit Engines

ITC’s core businesses, primarily cigarettes, FMCG, and paper/packaging, are more stable and generate consistent cash flows. The hotel business, on the other hand, is cyclical and requires significant investments to grow. By demerging the hotel business, ITC can streamline its operations and allocate resources more efficiently.

Why is this important?

• Stable Profits: ITC’s cigarette business is a cash cow, contributing significantly to the company’s revenue and profits. The FMCG segment, though growing, operates on thinner margins but offers long-term growth potential. Separating the hotel business allows ITC to focus on improving margins, scaling operations, and expanding market share in these core segments.
• Reduced Risk: The hospitality industry is prone to external risks like economic downturns, pandemics, and changes in travel trends. For example, during the COVID-19 pandemic, hotel revenues plummeted due to travel restrictions. By separating the hotel business, ITC reduces its exposure to these risks and protects its core revenue streams.
• Efficient Capital Allocation: ITC can now direct its financial resources toward growing its FMCG, paper, and packaging businesses, which typically offer better returns on investment compared to hotels.

Example: Imagine a successful restaurant owner who also runs a small hotel. If the hotel requires constant repairs and upgrades, it might drain the restaurant’s profits. By separating the hotel into a different business, the owner can focus on expanding the restaurant chain while the hotel grows independently.

3. Flexible Growth for ITC Hotels: Independent Fundraising Opportunities

The hotel business is capital-intensive, meaning it needs substantial investments to build, renovate, and maintain properties. ITC Hotels, as a separate entity, can now raise funds through equity (selling shares) or debt (taking loans) without affecting ITC’s financial stability.

Why is this important?

• Easier Access to Capital: ITC Hotels can now approach investors and financial institutions with its own growth plans. This flexibility allows the company to pursue expansion projects, such as building new luxury hotels, renovating existing properties, or acquiring other hotel chains.
• Preserve ITC’s Balance Sheet: When ITC Hotels raises funds independently, it doesn’t add to ITC Ltd’s debt. This helps ITC maintain a strong balance sheet, which is crucial for investor confidence and financial stability.
• Faster Expansion: As a standalone entity, ITC Hotels can make quicker decisions about investments, partnerships, and acquisitions. This agility is essential in the fast-paced hospitality industry, where trends and opportunities can change rapidly.

Example: Think of a teenager who wants to start a small business but relies on their parents’ finances. If the teenager gets their own bank account and starts managing their own funds, they have more freedom to grow their business without impacting the family budget.

4. Peer Performance

The recent stellar performance of hotel stocks like Indian Hotels, Chalet Hotels, Lemon Tree, etc also be a key factor in ITC’s decision to demerge its hotel business.

Post-COVID, the hospitality sector has seen a sharp recovery driven by pent-up travel demand, rising domestic tourism, and a rebound in global travel. These factors have led to a significant valuation expansion in hotel stocks, making them more attractive to investors.

By separating ITC Hotels, ITC can unlock the potential value of its hotel business. The hotel business of ITC can now be valued independently based on the recent market trends and future growth prospects in the booming hospitality sector.

The performance of hotel stocks indicates growing investor confidence in the sector. There is also a rising affluence and demand for luxury and leisure travel.

ITC likely saw this opportunity to capitalize on the strong market sentiment around hospitality. I think, this is an opportunity for ITC Hotels to raise funds more efficiently and benefit from investor interest.

After the demerger, I think, ITC Hotels can be valued based on its own merits.

The demerger of ITC Hotels is a strategy that is likely to benefits both ITC Ltd and ITC Hotels.

Is This Demerger Good News for Existing ITC Shareholders?

Yes, it is! Here’s why:

1. Value Creation: As ITC Hotels gets listed separately, the hotel business can be valued independently. If the hotel business performs well, it will add more value to the ITC Ltd business and hence its shareholders.
2. Focused Growth: ITC’s core businesses (FMCG, cigarettes, and packaging) are now free to grow without being weighed down by the heavy costs of the hotel segment. This should improve ITC’s overall profitability.
3. More Investment Choices: After the demerger, one will own shares of both ITC Ltd and ITC Hotels. If you believe in the future of the hotel industry, you can keep ITC Hotels’ shares. If not, you can sell them and invest elsewhere.

Example: Imagine you own a general store and a restaurant. The general store is profitable year-round, but the restaurant’s profits fluctuate. By separating the restaurant into a new business, you can focus more on growing the general store while giving the restaurant its own chance to attract customers and investors who love dining businesses.

What About New Investors? Will I Buy ITC for the Next 10-15 Years?

Yes, but with conditions.

Here’s what we need to consider:

• Stable Core Business: ITC’s core businesses, especially its cigarette and FMCG segments, generate consistent profits. The cigarette business alone controls 78% of the Indian market, making ITC a near-monopoly. This means steady cash flows, which the company can use to pay dividends and invest in new growth opportunities.
• Dividend Payouts: ITC is known for rewarding its investors with dividends. In the past year, it paid Rs 13.8 per share as dividends, yielding a solid 2.63%. If you like regular income from your investments, ITC is a reliable choice.
• Growth Potential: ITC’s FMCG segment, though smaller than giants like HUL, is growing. ITC is expanding into food, personal care, and even newer categories. The company expects a margin improvement of 0.8-1% annually in this segment.
• Challenges and Alternatives: While ITC is a good option, it’s important to compare it with other diversified companies like Hindustan Unilever (HUL) and Reliance Industries.
  • HUL: Dominates the FMCG market but offers lower dividend yields compared to ITC. It’s a great long-term bet for steady growth.
  • Reliance: Diversified into oil, telecom, and retail. Offers high growth potential but comes with higher risk.

Example: If you’re a cricket fan, think of ITC as a consistent middle-order batsman who scores steadily and gives you peace of mind. HUL is like an opener who plays safe, while Reliance is a hard-hitting all-rounder who can win the match but might also get out quickly.

Conclusion

For long-term investors, ITC remains a strong pick because of its stable profits, attractive dividends, and growth potential in FMCG. The demerger adds even more value by allowing ITC to focus on its strengths while giving ITC Hotels a chance to thrive independently.

If I’m looking for steady returns with lower risk, ITC is a reliable option for me.

However, if I want higher growth and can tolerate more risk, I’ll consider adding companies like HUL or Reliance to my portfolio.

The ITC Hotels demerger is a strategic move that benefits existing shareholders and offers new opportunities for future growth. Whether one is an existing or new investor, ITC’s diversified business and consistent performance make it a worthy consideration in ones investment portfolio.

But it is also essential to do a detailed fundamentals analysis of the demerged entity. Remember to do your research and ensure your investments align with your financial goals and risk tolerance.

What are your thoughts on ITC’s demerger? Do you plan to hold or buy more ITC shares?

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Have a happy investing.