Decoding ITC's hotel business demerger: What investors need to know about the move

ITC's board on Monday gave in-principal approval to demerge its hotels business under a scheme of arrangement with ITC continuing to have a 40% stake in the new entity (ITC Hotels) and the balance of 60% to be held directly by the shareholders.

The final consideration and approval of the proposed transaction will be determined by the ITC board during their next meeting scheduled for August 14, 2023. If approved by the board, the scheme of demerger will be subject to necessary approval from shareholders, creditors, stock exchanges, SEBI, NCLT, and other regulatory authorities, as required.

Following the demerger announcement, traders sold ITC shares, resulting in a 3.90% drop in share value on Monday, and the selling extended to Tuesday with another 1.92% fall, resulting in a cumulative loss of nearly 6%.

According to analysts, the recent surge in ITC shares was driven by anticipation of the hotel business demerger. However, as soon as the official announcement of the demerger plan was made, traders started selling the stock.

Let's take a closer look at how this proposed de-merger will unlock value for ITC shareholders and the company.

Hotel business on strong footing

ITC has a diversified presence in cigarette packs, hotels, paperboards and speciality papers, packaging, agri-business, packaged foods and confectionery, information technology, branded apparel, personal care, stationery, safety matches, and other FMCG products.

Over the last two decades, the company's hotel business has scaled up significantly and in the last 10 years, its revenues grew at a CAGR of 9%. Today, ITC holds 120 properties with over 11,600 keys across 70 locations under six brands in luxury, premium, and budget segments, said brokerage firm Centrum Broking.

ITC’s hotel business ranked among the fastest-growing hospitality chain in India, with marquee brands such as ‘ITC Hotels', ‘Mementos’, ‘Welcomhotel’, ‘Storii’, ‘Fortune’, and ‘WelcomHeritage’.

The hotel business contributed 3.7% of ITC’s overall sales in FY23 and made up an EBIT contribution of 2.3% with an EBIT margin of 22% (the highest margin since FY12).

With a rise in domestic tourism, the brokerage expects the hotel business to clock healthy revenues over the next two years.

Strategic rationale behind proposed demerger of hotels business

According to ITC, the hotels business has matured and is now well-positioned to pursue its own growth path as a separate entity. By creating a distinct Pure Play hotels entity, the aim is to foster the next phase of growth and deliver sustained value for shareholders.

This new entity will operate with an optimal capital structure, enabling it to access equity and debt markets to fund its growth requirements. The demerger will unlock value for ITC shareholders by providing them with a direct stake in the pure-play hotel's entity. Additionally, an independent market-driven valuation will be conducted for the focused new entity, the company added.

The demerger will also allow continued access to cross-synergies and reinforce ITC's sharper capital allocation strategy, characterised by an "asset-light" approach and higher dividend distribution, it added.

Overall, the strategic rationale behind the proposed demerger aims to enhance the potential for growth and value creation in the hotels business as a separate entity.

Not game-changer but signals a sharper capital-allocation focus

Global brokerage firm JM Financial said that ITC's proposal to demerge its hotels business was not a game changer but points towards a sharper capital allocation strategy.

The brokerage has pointed out that ITC's management has recognised the recurring concerns among investors about significant investments in the hotels venture. To address this, the company shifted to an 'asset-right' strategy for the hotel business, prioritising management contracts and reducing capital expenditure on owned hotels as much as possible.

As a result of this shift, the capital employed in the hotels segment has grown by only about 4% cumulatively over FY19–23, compared to a growth of approximately 58% in the preceding five-year period, it noted.

While this strategy aims to address investor concerns about excessive investments in the hotels venture, it may also limit the business's access to capital for its growth and potential opportunities.

By structuring the ownership differently through a demerger, ITC can still participate in India's hospitality growth story while reducing its own capital involvement in driving growth within the segment. The demerged unit would have the freedom to make its own decisions on capital-raising and deployment without relying on ITC for funding each time capital is needed, the brokerage stated.

Outlook and valuation

Centrum Broking expects the revenues of the hotel business to reach ₹38.7 billion in FY25E with an EBITDA margin of 34.1%, led by strong growth in domestic demand for the hospitality sector.

The brokerage assigned EV/EBITDA on FY25E at 25x to arrive at a per-share value of ₹27. Overall, the brokerage has a positive outlook on this development and retained its 'buy' rating on ITC with a target price of ₹486 (implying 22.4x P/E for FY25E EPS).

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of MintGenie.