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Of Cash cows and Stars- ITC & Reliance

A strong consistent cash generation engine is the holy grail for most firms. Yet few firms are able to build these engines and the ones that do find themselves unable to deploy the money well. In today's piece, we look at two companies from two very different sectors who have taken different approaches to the same problem - using their dominant cash cows to build the stars of the future.

The opex play - ITC

ITC, the country's largest cigarette manufacturer has a business that the government loves to hate. Every year's budget levies some additional cess or tax on the firm. The firm passes through most of it via a price hike. Analysts get spooked, earnings estimates get revised downwards, but the company marches on - only to see the same thing repeated next year. There is no business in the world where your product kills the user, you have a dominant graphic label on your product stressing it would kill the user and yet, consistently, year after year, your user comes back - no business but cigarettes. Our job here, however, is not to pass value judgments on the decisions of adults with free will - and while we do not condone smoking, it is important to understand the durability of the business and its ability to generate cash consistently despite all attempts to thwart it. The business generates more than 80% of the operating income for the firm, and helps the firm nurture its star -"other FMCG".

Aashirwad(#1 in branded flour), Sunfeast(#1 in cream biscuits), Bingo(#2 in Chips), Yippee(#2 in Noodles) and Candyman(Candy) are just a few of the many names in the FMCG stable of ITC. The business generated north of 12,500cr in the previous financial year starting from a meager 109cr in 2003. Having the backing of its cash cow business - cigarettes to fund the FMCG business has meant that the firm could make low margins, even lose money as they gained share in the key segments they operated in. The firm has been very realistic in its understanding of the pressures that will grow on the traditional cigarette business and the large investments in brand building necessary in growing FMCG. And it has done just that, taken hits on margin consistently as it grows the business.

The capex play - Reliance

Reliance is a household name in India - with the rags to riches story of its entrepreneurial found, Dhirubhai Ambani told and retold many times. Reliance too has amongst the most impressive cash generation engines in the business - PetChem. This business is unglamorous in most ways generating products that go into making everything from water bottles to polyester clothing and from sacks to shoes. And yet like most things in life - the real money is often in the things without much glamour. In the last financial year, the business churned more than ~32,000 cr of operating income on revenue of ~170,000 cr. Every year, this otherwise unglamorous business generates close to half of the operating income for the firm.

All the cash that the firm generates from the business has allowed it to grow from virtually no presence in 2016 to the #1 telecom player in the country in less than 4 years. The huge upfront capital expenditure that went into building the infrastructure for Jio was pivotal in taking the firm to the close to 370 million subscribers it has today. While the gradual decline in oil and related petrochemicals is highly likely over the next few years, the bold move into telecom with large capital spend has allowed the firm to cement it position in a growth driver of the future, much to the chagrin of the incumbents in the space.


About the Author: The post is written by Ganesh Nagarsekar. Ganesh is a graduate from IIM Calcutta and has worked with J.P. Morgan and Goldman Sachs, before founding GSN Invest.

Disclaimer: This is an attempt to explain one aspect of the business strategy of these firms. This is NOT an investment recommendation. Please conduct your own research or seek advice your a registered investment advisor before taking an investment decision.


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