Jefferies downgrades ITC to ‘Hold’ as British American Tobacco considers selling stake

Jefferies downgraded ITC Ltd. from ‘buy’ to ‘hold’ following British American Tobacco’s decision to sell a portion of its stake in the company. The brokerage also lowered the stock’s target price from Rs 520 to Rs 430 per share, suggesting a 2.8% potential increase.

Jefferies predicts that due to the BAT stake sale, upcoming taxation events, and slower volume growth, ITC’s stock will likely stay within a certain range in the future. Meanwhile, BAT stated in a release after its quarterly results that it holds a substantial stake, allowing it to potentially free up capital by monetizing some of its shares, a process it has been actively pursuing after completing necessary regulatory procedures.

During its post-earnings call, BAT mentioned that holding a 25% stake is adequate to maintain strategic influence, compared to the current 29%.

Jefferies predicts that a potential 4% stake sale, valued at $2.5 billion, could lead to an oversupply situation.

The brokerage noted challenges faced by BAT due to declining cigarette volumes, particularly in key markets like the U.S., resulting in a recent $32 billion write-down. Analysts at Jefferies are also concerned about a near-term slowdown in cigarette volume growth.

During a recent analyst meeting, ITC’s chairman mentioned the likelihood of consolidation in cigarette volumes in the near future after reaching a nearly 10-year high.

What are BAT’s comments regarding its intention to sell its stake?

BAT stated, following its quarterly results, that it regularly evaluates its stake in ITC, leveraging its substantial shareholding for potential capital reallocation. While BAT holds a 29.03 percent stake in ITC, it’s not classified as a promoter, similar to L&T, another company lacking an official promoter. LIC is another significant shareholder with a 15 percent stake.

This isn’t the first time such stake sale speculation has surfaced. In a conference call in December 2023, company management responded to an analyst’s query about selling their ITC stake, highlighting ITC’s strong performance and undervaluation relative to its peers.

What portion of its stake does BAT plan to sell?

In December, BAT mentioned that holding a 25 percent stake in ITC allows it strategic influence, including veto rights. With its current 29.03 percent stake, it could sell up to 4.03 percent, valued at roughly Rs 21,000 crore.

This suggests BAT aims to maintain a 25 percent stake. Given this, the market’s reaction may be excessive, as there’s likely significant interest from various investors in buying the 4.03 percent stake BAT plans to sell.

Why does BAT require regulatory approval to divest its stake in ITC?

In December, BAT acknowledged challenges in divesting its ITC stake due to regulatory hurdles. These include the Indian government’s FDI ban in tobacco and permissions required from the RBI.

Despite these obstacles, BAT expressed a desire to monetize its holdings and indicated ongoing efforts to address regulatory concerns. While there have been no official changes, BAT’s recent statement suggests progress or at least ongoing dialogue regarding the regulatory process for stake monetization.

What comes next?

BAT’s management clarified in a recent conference call that they have no plans to reduce their stake below 25 percent, which is the minimum required to maintain influence as per local regulations.

 If approvals are obtained, they are likely to offer a 4.03 percent stake for sale. They are actively engaged in the regulatory process, working with both ITC and relevant authorities like the RBI to secure necessary approvals. However, they mentioned that there is no definite timeline for this process.

Is there genuine cause for shareholder concern?

Investors are most concerned about one particular scenario. If the stake ends up in the hands of portfolio investors like mutual funds or foreign funds, it increases the floating stock, resulting in more shares being traded. Initially, this surplus stock might be viewed negatively, but in the long term, the stock’s fundamentals should have a greater impact on its valuation. It’s worth noting that selling Rs 21,000 crore worth of shares in a market with a capitalization of Rs 5.2 lakh crore doesn’t seem like a significant dilution.

However, if there are plans to sell a larger stake or if investors interpret this move as a precursor to future stake sales, it could cast a shadow over the stock.

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