What ITC hopes to achieve by demerging its hotel business

Salt-to-cigarettes major ITC Ltd is spinning off its hotels division—after nurturing it for over two decades—into a separate company in an effort to accelerate its growth and improve resource allocation. The company’s board has given its in-principle approval to the demerger, long-awaited by the company’s shareholders and market experts. The board will still need to ratify the specifics of the demerger on August 14. According to the proposed structure, ITC’s management would hold a 40 per cent stake in the newly established entity that will house its hotels assets and business, while the remaining 60 per cent will be owned directly by ITC shareholders proportionate to their shareholding in the company.

Experts say the board’s decision is pragmatic, based on the realities of the market. ITC had brought the hotels business under its fold in 2004 by merging the then-listed ITC Hotels Ltd and Ansal Hotels Ltd into it. But over the past few years, there has been a consistent outflow of money to finance the hotels division despite lower returns. As per estimates by Nuvama Institutional Equities, the hotels business currently “guzzles 20 per cent of (ITC’s) capital”. In comparison, it contributed Rs 2,689 crore, or 3.5 per cent, to ITC’s Rs 76,518 crore top line. But at Rs 852 crore, the hotels business contributes less than 3.5 per cent to the total Ebitda (earnings before interest, taxes, depreciation, and amortisation) of the group. In fact, the performance of ITC’s hotels division lags leading hotel companies in the country. Take Indian Hotels Company (IHCL) for comparison, which reported revenues of Rs 5,949 crore in FY23, while its Ebitda stood at Rs 1,943 crore, with an Ebitda margin of 32.7 per cent, against ITC’s 31.7 per cent.

However, ITC’s management is certain that the demerger will boost both the company’s efficiency in allocating capital and improve profitability. In an analyst call after the demerger was announced, the leadership said that they expect a rise of 18-20 per cent in ITC Ltd’s return on capital employed (ROCE) after the demerger; while its return on invested capital (ROIC), a measure of how successfully a company allocates resources to profitable projects or investments, may rise by 10 per cent. According to the company’s management, the separated hotels business will have a strong debt-free balance sheet and it’ll also be well-capitalised. The demerger will also allow the spun-off firm to chart its own growth path, raise its own resources and funds based on an “asset-right” strategy (which means the assets they will hold or purchase will be based on in-depth research to ensure that they are optimal in the overall scheme of things), and leverage ITC’s goodwill, brand value, synergies, and more, to stabilise the hotels business.

The management says the demerged entity would continue developing its hotels business through management contracts, especially for emerging brands like Storii and Mementos. Global financial services company Morgan Stanley has stated in a report that the demerger should enhance ITC’s financial ratios and unlock value for shareholders by providing them with a direct interest in the pure-play hotels sector.

Under ITC’s direct fold, the hotels business has expanded its revenues at a compound annual growth rate of 11 per cent and inventory at 160 per cent to 11,600 rooms, at the end of FY23, from 4,472 in FY03. With Covid-19 behind us and corporate and leisure travel back on track, analysts expect the move to enhance ITC’s hotels business in the coming years while increasing capex in the company’s core fast-moving consumer goods business.

Analysts from Nuvama say the hotels industry has recovered well post-Covid-19, and a favourable demographic profile and affluent aspirations offer further growth potential. They expect the newly listed company to become the second-largest hotel company in the country with a Rs 25,000-crore market capitalisation. “The tourism business in India is in a bright spot. There are several favourable policies to support the sector,” they note, adding that the hotel industry’s five-year supply is expected to grow at a CAGR of 5 per cent, which is likely to be outpaced by demand—pegged at more than 7 per cent for the period. With net assets of Rs 5,500 crore, the demerged entity’s own accruals should be enough to fund its expansion goals, Jefferies analysts note.

According to Sanjiv Puri, Chairman of ITC, the proposed demerger is a testament to ITC’s commitment towards creating sustained value for stakeholders. “Creation of a hospitality focussed entity will engender the next horizon of growth and value creation by harnessing the exciting opportunities in the Indian hospitality industry. In the proposed reorganisation, both ITC and the new entity will continue to benefit from institutional synergies,” he said in a statement.

Subject to approvals, the management has proposed the new entity be named ITC Hotels Ltd. While they are yet to declare a date of its listing, Nuvama estimates it will take place within 12-18 months.

@arndutt