ITC's Hotel Business Demerger Plan Failed To Cheer Investors. Here's Why
Shares extend losses for a second day even as the move is expected to unlock value for investors.
Ending months of speculation, ITC Ltd. has officially announced a demerger of its hotel business. But shares of the cigarette-to-hotel major fell sharply on Monday after hitting a 52-week high during the day following the board's in-principle approval of the demerger.
The move to carve out the hotel business into a separate unit is expected to unlock shareholder value with a direct stake in the new entity, but the move has disappointed ITC investors, with the stock crashing as much as 4%. The slide continued on Tuesday with the stock trading 3% lower at 10:40 a.m. versus an almost changed Nifty 50.
ITC has decided to retain 40% of the demerged entity, while the remaining 60% will be owned by the shareholders proportionate to their holding in the company, according to the proposed plan. The company's decision not to do a full split of the hotel business has dampened investor sentiments.
"The demerger ratio announced is not quite favourable to existing shareholders," said Apurva Sheth, head of market perspectives and research at SAMCO Securities. "Since shareholders are not getting one share for each share they are holding, they are disappointed."
Markets have been gung-ho about the demerger because the hotel business has been a drag on ITC’s books. The hotel division had been a capital guzzler, accounting for over 20% of ITC's capex. However, it contributed less than 5% to ITC's revenue and EBIT over the last decade.
The demerger will remove the overhang from investor concerns about hotels being a low return-on-equity business, allowing them the option to stay only with ITC’s high-return businesses.
ITC has made efforts to move towards an asset-light approach in line with the industry trend of large players moving towards management contracts. Though over half of the current room inventory is through management contracts, the company's revenue remains skewed towards its own hotels.
The country's second-largest hotel chain has an inventory of more than 11,500 rooms across over 120 hotels in more than 70 locations.
Another possible reason for the sell-off could be profit-booking.
"The market was anticipating developments on the demerger. Hence, once the cat was out of the bag, the only logical reaction was to book profits and move on to the next stock," said Sheth.
According to analysts, this is the right time for a demerger as the hospitality sector is poised to exhibit robust profitability as compared with the pre-Covid era.
On the back of key metrics such as occupancy rate, average rental revenue per occupied room, and revenue per available room, ITC's hotel segment Ebitda margin expanded to an all-time high of 32.2% in FY23.
"Given the market opening up after the Covid debacle, we factor in margin expansion of 33.5% by FY26E," said Emkay. The brokerage also factored in a 13% top-line CAGR over FY23–26E, with EBIT growth of 21%. As of FY23, ITC’s hotel business contributed Rs 2,585 crore to the top line and Rs 541.9 crore to EBIT.
"The stock faces technical pressure, with a close below Rs 468 potentially bringing more challenges, while long-term support near Rs 450 levels warrants caution and observation for potential volatility," said Prashanth Tapse, senior vice president and research analyst at Mehta Equities Ltd.
The proposed hospitality-focused entity aims for growth and value creation in the Indian hospitality industry, benefiting both ITC and the new entity through institutional synergies. More clarity on the scheme of arrangement is awaited, with a board meeting slated for Aug. 14.