India's cigarette giant makes a healthy choice but a difficult ride

By Nandita Bose and Abhishek Vishnoi
MUMBAI, Sept 6 | Wed Sep 5, 2012 4:59pm EDT
(Reuters) - India's biggest cigarette maker is going on a health kick.

ITC Ltd sells 80 percent of the cigarettes in the world's second most populous country where 275 million people use tobacco products.

But as India follows the rest of the world in adopting anti-smoking regulations, the company's core tobacco business is getting squeezed and it is venturing into dairy products, drinks and perhaps even he a lthy breakfast foods to tr y to expand its money-losing consumer products business.

"Indians are turning health-conscious in their food choices, so health and nutrition will be a very strong focus area for us in the coming years," Chitranjan Dar, chief executive of ITC Foods, told Reuters in a phone interview.

ITC, India's fifth most valuable company with a market capitalisation of $38 billion, already makes cookies, crackers and potato chips, so expanding into dairy and breakfast foods is not that big of a stretch.

But healthy food marks a sharp turn for a company best known for cigarettes. Although ITC got into the food business a decade ago, cigarettes account for half the company's revenue and even its initials are a throwback to its century-old roots when it was known as Imperial Tobacco. The company is 30.8 percent owned by British American Tobacco.

Building market share in food and consumer products may be difficult. With the exception of packaged flour, where ITC holds a leading position, the company has not won more than 15 percent of the market for any product category in which it competes.

It has spent 45 billion rupees ($809 million) building up its food and consumer product segments over the past 10 years, according to analysts.

"No other consumer company has invested such sums of money without creating a relevant share in any category," said Nikhil Vora, managing director at Mumbai-based IDFC Securties.

Vora's firm downgraded the stock to underperform from outperform after Australia barred the use of logos on cigarette packs on Aug. 15, sparking speculation that India's regulators would follow.

Investors initially knocked $1.3 billion from ITC's market value after Australia's move, although the stock has since recovered, in part because most smokers in India buy cigarettes in single sticks, not packs.

An investor favourite for its defensive characteristics, ITC shares have risen 32 percent this year, outpacing the 13 percent rise in the index.

ITC makes Sunfeast biscuits, Bingo snacks and the Fiama Di Wills range of soaps and shampoos, competing with the likes of Hindustan UnileverLtd, Procter & Gamble Co, Godrej Consumer Products Ltd and Dabur India Ltd in a price-sensitive market worth $13 billion and growing at 15-20 percent a year.

Its consumer goods sales rose 24 percent to 55.3 billion rupees in the year to March, accounting for 22 percent of total ITC revenue, although the business was a drag on overall profit, losing 1.96 billion rupees before interest and tax.

It aims to triple revenue from consumer goods over the next 5 to 7 years.

"What we have achieved is not bad for a business that is a decade old in this space," ITC's Dar said, adding that parts of its consumer goods business were "profit positive."

CIGARETTES AND FOOD

ITC is not the first company to try to mix cigarettes and food. Tobacco giant Altria Group Inc, formerly known as Philip Morris, bought Kraft Foods in 1988, although it later spun off the food company and has returned its focus to tobacco.

Tighter regulations add urgency to ITC's food drive.

India has followed global trends in tobacco restrictions, banning smoking in public places in 2008 and a year later requiring graphic health warnings on cigarette packages.

It has steadily raised taxes on tobacco products, most recently by 20 percent. Analysts said that contributed to an unexpected 3 percent drop in ITC's cigarette volume sales in the June quarter.

Some Indian states are also raising taxes. Uttar Pradesh, the most populous, in July raised the value-added tax on cigarettes to 50 percent from 17.5 percent, prompting speculation that others will hike taxes too.

ITC has set up 7 new plants this year to support its consumer products expansion, and plans to test new categories including coffee, tea and dairy products that can be stored at room temperature.

"Almost all the categories they operate in this space already have large established players, so clawing away market share from them wont be easy," said Pinakiranjan Mishra a partner with Ernst and Young who focuses on consumer products and retail.

"Their distribution strength can make a difference but their aim to triple growth in a few years still looks very tough," he said.