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ITC: Enduring Value

Sab Saath Baadhein

Chairman speaks

Chairman Speaks - 1999

STRIDE TOWARDS COMPETITIVENESS

Speech by Shri Y.C. Deveshwar, Chairman, ITC Limited at the 88th Annual General Meeting of the Company held in Kolkata, India on July 30, 1999

It gives me great pleasure to welcome you for the fourth successive year after being elected as Chairman of your Company. These last four years have been challenging ones both for the Indian economy and for the Indian industry. India has witnessed five governments during this short period. The country is getting ready for yet another general election. The substantial erosion in the value of the currencies in Russia, South East Asia and Latin America intensified price competition for Indian exports on the one hand, and made imports into India attractive on the other, thereby adversely impacting the financial performance of many Indian enterprises. Investment sentiment has been at a low ebb. The growth rate of the Indian economy came down from 7.8% in 1996-97 to 5.8 last year. This rate of growth is woefully inadequate. According to an estimate of the Confederation of Indian Industry, even if the Indian economy were to grow at 7% per annum consistently over thirty years, the resultant per capita income would barely match the levels obtaining in Thailand today. It is therefore evident that India must target a much higher rate of growth. Such an ambitious growth agenda in a fast globalising environment can only be realised through an accelerated reform process that makes the Indian economy globally competitive and thereby attract commensurate investment.

There is therefore a crying need for a consensus on an economic reform agenda. The unanimous adoption of the Union Budget seems to have helped revive sentiment and there are early signs of economic recovery. The economic resilience that is being demonstrated during an uncertain political phase is indicative of the potential of a much faster rate of growth once political stability is restored and a second generation of reforms takes concrete shape. The globalising market and the prospects of a higher growth rate whilst presenting opportunities, pose formidable challenges.

As I had stated in earlier years, competitiveness continues to be a compelling agenda for the Indian industry. The task of transitioning businesses from a relatively protected environment to the rigours of a globalised market requires upgradation of capabilities to international standards. This implies a major change in mindset, backed by substantial investments in modernisation, scaling up and skills upgradation. Such strategic investments would naturally entail gestation drags that would severely test managements for their staying power and commitment to their businesses. Business portfolios will therefore need to be rationalised and restructured for focused attention so that the deployment of scarce resources is confined to those areas that best match organisational capability with market opportunity. Those who fail to overcome these challenges would succumb to the severity of competitive pressures, while those who succeed would be handsomely rewards. It is therefore imperative to shed preoccupation with the mere maximisation of tactical financial results, and instead focus on building strategic capabilities. A wholesome balance will have to be struck between the short, medium and long terms.

In line with such reasoning, and with the objective of fashioning a sustainable growth path, I am pleased to state that considerable progress has been made by your Company over the last few years.

       PROGRESS IN RESTRUCTURING


Investment Subsidiaries

Company's investment subsidiaries have since been received and consequently, Summit and Sage Investments stand merged with Russell Credit with effect from 1st February 1999. Russell Credit's Balance Sheet size now stands at Rs. 671 Crores.

Investments in Edible Oils

Shareholders are already aware that ITC had exited completely from the management of this business by transfer to control of ITC Agro-Tech to ConAgra. Your Company's investment subsidiary Russell Credit, holds a minority interest of 17% in ITC Agro-Tech currently valued in its books at Rs. 53 crores. The market value of this investment as at 22nd July 1999 was around Rs. 71 crores. Further, the Mantralayam facility which was licensed to ITC Agro-Tech and the Mantralayam land are held in your Company's books at
Rs 104 crores. On the basis of the agreements among ConAgra, ITC Agro-Tech and your Company, ITC would be in a position to disengage from these investments only after October 2000 and redeem these assets on the basis of their market values obtaining then. Concurrently, the use of the ITC prefix in the name of ITC Agro-Tech would stand withdrawn.

Investments in Financial Services

Following the merger of ITC Classic with ICICI, your Company was to cause the disposal of ITC Classic's investments in the home finance and stock broking businesses. The home finance company has since been sold for a consideration of Rs. 10 crores and an agreement is in place to liquidate ITC Classic's interest in the stock broking business, pending requisite regulatory approvals. Further, negotiations with the Zurich Financial Services group are at an advanced stage for the ITC group's exit from the asset management business of ITC Threadneedle.

As a result of the disengagement from the erstwhile ITC Classic group of companies, your Company's investment subsidiary Russell Credit now holds shares of ICICI valued in its books at Rs. 5.7 crores. The market value of this investment as at 22nd July 1999 was about Rs. 10.5 crores. In addition, there is an exposure of Rs. 350 crores in the form of preference shares of ICICI redeemable at par in the year 2018.

Additionally, in the course of such restructuring, your Company and its subsidiaries have had to deploy around Rs. 360 crores in Real Estate projects. Although the real estate market is currently depressed, it is expected that your Company would be in a position to redeem these investments over time at a reasonable surplus. Towards this end, your Company is engaged in creating an organisation and assembling the requisite management skills to chalk out development plants for subsequent execution. Opportunities for partnerships with reputed international players are also being explored to maximise returns from these assets.

Investments in Paperboards

As a result of the infusion of capital approved by you last year, ITC Bhadrachalam Paperboards Limited has now become a subsidiary of your Company facilitating closer management attention in line with the strategy of focus.

Investments in Speciality Papers

In respect of specialty papers, efforts towards striking a partnership with a suitable international player to reposition this business on a growth path are continuing. This is likely to take time on account of the depressed sentiment in the international markets resulting from the deep recession witnessed in the global paper and pulp industry. In the meantime, vigorous efforts at improving quality and cost standards are continuing to make this business more attractive for potential partners.

The aggregate tie up of funds in what may be termed as non performing assets as a result of restructuring towards disengagement from non core activities, and on account of the excise pre-deposit of Rs. 350 crores, amounts to around Rs. 1,260 crores. The associated drag arising therefrom needs to be kept in mind while viewing the financial results of your Company, particularly in the year under review.

       REVIEW OF OPERATING AND FINANCIAL RESULTS


The last year yet another year of satisfying performance for your Company despite difficult trading conditions. In spite of business sentiment continuing to be depressed in the face of weak domestic demand, extremely competitive export markets and lacklustre industrial growth, your Company continued to post creditable results. While turnover grew by 11% to Rs. 7,579 crores, trading profits, at Rs. 1,092 crores, increased by an even more impressive 25% to cross the one thousand crore mark for the first time. After absorbing the additional interest burden as stated earlier, net profits at Rs. 623 crores represented a growth of 18.5% over the previous year. I am sure that these results, seen in the context of declining inflation, stop substantial growth in profits in preceding years, is a source for satisfaction of our shareholders.

The last few pages of the Report and Accounts provide at a glance, the progress that your Company has made in operating and financial results. The reserves have more than tripled since 1995 at Rs. 1,988 crores. This enabled the debt equity ratio to be contained at a healthy 0.56 : 1 despite the substantial increase in the size of the Balance Sheet from Rs. 1,640 crores in 1995 to Rs. 3,486 crores in 1999. This has been made possible by significant improvements in operating cash flows. The capital markets have handsomely acknowledged the performance of your Company, with the growth in market capitalisation of you Company having significantly outperformed that of the BSE Sensex.

Your Board is committed to the creation of long term shareholder value. Each of your Company's businesses is in a different phase of development requiring distinctive focus and investment for the successful transition from a position of dominance in the regulated market of yesteryear, to a position of leadership in the highly competitive markets of tomorrow. It will therefore periodically review the portfolio of businesses for sustainable competitiveness and take necessary strategic alliances and partnerships, and even exiting from a business objective is not attained with sustainability in a reasonable time span.

The strengthening Balance Sheet of your Company will provide the much needed staying power in building leadership positions in the capital intensive hotels and paperboards businesses, as also in supporting investments in modernising the tobacco, cigarette and packaging businesses.

       STRATEGIC PROGRESS IN CORE BUSINESSES


Cigarettes and Leaf Tobacco

Your Company has invested nearly Rs. 500 crores during the last three years towards upgradation and modernisation of its manufacturing and product development facilities. The new plant outside Bengaluru, when completed at an estimated outlay of Rs. 450 crores, would provide state-of-the-art facilities for the next millennium. The first module, at an investment of nearly Rs. 100 crores, has now been completed and commercial production is scheduled to commence shortly. Similarly, the modernisation project at the Saharanpur plant has been completed at a cost of approximately Rs. 80 crores. As a result of these investments, the internationally preferred high value "Hinged Lid" form of packaging, which constituted 2.4% in 1995-96 now constitutes 22% of your Company's production. Concurrently, filter cigarettes now constitute 69% as opposed to 60% in 1995-96, thereby providing your Company the benefits of the high value addition. Such investment in brands will continue, with outlay of over Rs. 700 crores envisaged over the next 5 years. Continuous improvement in quality and cost standards has further strengthened your Company's market standing.

The export of leaf tobaccos suffered a setback during the year under review as a result of a glut in the international tobacco markets. The adverse impact on the farmer was exacerbated by overproduction by the farmer above the limits mandated by the Tobacco Board. Your Company purchased quantities beyond its immediate requirements as a measure of assistance to the farming community, who are viewed by your Company as long term partners in business. The adversity on the tobacco export front is likely to continue in the foreseeable future. In order to enhance the competitiveness of Indian tobaccos your Company continues to enlarge and upgrade its development and extension services to the farmers. Initiatives are also on the anvil with regard to development of Oriental type of tobaccos, the cultivation of which is highly employment intensive and which has a growing demand in the international markets. Concurrently, to support export efforts, modernisation plans to upgrade green leaf tobacco processing facilities at an outlay of nearly Rs. 350 crores are in hand for implementation over the next five years.

Hotels and Tourism

Your Company commenced the hotels business way back in 1975. For reasons of competing demands from newer businesses such as financial services and edible oils, fresh investments did not take place at the desired rate in the 80s and the early 90s. As a result, Welcomgroup could not expand its presence to several high potential locations, which would have considerably strengthened the chain. In an endeavour to offer a more complete and attractive chain product to upmarket international and domestic business travellers, an expansion plan involving investments of over Rs. 1,500 crores in the next five years is under implementation. The Rs. 450 crore five star deluxe hotel project at Mumbai is progressing satisfactorily and is slated for opening in October 2000. The civil works for the 100 bay expansion at Maurya Sheraton in Delhi is nearing completion and is planned for opening in March next year. Preparations to commence construction of a second hotel in Mumbai on you Company's land at Parel and five star deluxe project at Calcutta are at an advance stage. These projects are likely to be completed by the years 2001-02 and 2002-03 respectively. I am also happy to advise you of the induction of a second hotel into the Welcomgroup chain in Delhi, which is at an advanced stage of construction. On completion of the expansion plans, nearly 1,500 deluxe rooms will have been added to the Welcomgroup chain over the next five years.

These investments, apart from providing an attractive growth opportunity to your Company, would stimulate large direct and indirect employment besides supporting substantial foreign exchange earnings from international travellers. Your Company views these investments as a significant contribution to the development of infrastructure for trade and commerce in the country. Although this capital intensive business carries gestation drags in the short term, the long term potential for earnings and real estate appreciation is attractive. In the globalised world of tomorrow India can acquire a position of leadership in the employment intensive Services business. It is expected that after your Company acquires a critical size and scale of operations in the Indian market it can successfully venture overseas and acquire a global dimension.

Packaging and Paperboard

Significant progress is being registered in the packaging business of your Company. You would recall my statement last year, that any in-house buyer-supplier relationship within the ITC group is governed by a policy framework that provides freedom to the buyer to access the most appropriate inputs from the market. The in-house supplier has to earn the custom through superior quality and cost. You will be happy to learn that the packaging requirements of the cigarettes business, that were earlier being sourced from overseas in pursuit of international quality standards, have now reverted to you Company's packaging business, with considerable gains in efficiency and substantial savings in costs and foreign exchange outgo. This achievement has also provided the packaging business the impetus to grow exports of value added packaging to overseas tobacco companies. While pursuing organic growth, opportunities for acquisitions are also being explored.

You are already aware that ITC Bhadrachalam Paparboards Limited, now a subsidiary of your Company, has been engage in the stabilisation of the recently capitalised 120,000 tonne capacity plant involving an outlay of nearly Rs. 675 crores. Unfortunately this new investment had coincided with a deep supply demand adversity, both in the domestic and global markets, intensifying price competition, thereby leading to serve erosion in margins. Focused product development efforts together with early signs of revival of the paper and pulp industry give the hope that the turnaround of this business can begin to take place in the not too distant future.

Attainment of international competitiveness by Indian enterprises would largely depend upon the interplay of two mutually supportive ingredients. The first one relates to the vitality of the enterprise in reshaping its business portfolio to align more closely with its unique capabilities, inculcating dynamism in leadership, investing in technology and human skills to nurture core capabilities, and evolving appropriate governance processes to enhance the wealth generating capacity of the enterprise. The second relates to the vitality of the economy as a supplier of globally competitive inputs and resources. In this context, the social and physical infrastructure in our country needs urgent and quantum upgradation. Equally, the institutional and policy framework needs to be progressively reformed to create a climate in which efficient entrepreneurial activity is rewarded and resources made more productive.

Industry and government therefore need to work in close partnership to fashion a policy framework appropriate to each industry. I would like to place before you an area related to the tobacco industry that requires urgent attention.

        REFORM OF THE REGULATORY FRAMEWORK FOR THE TOBACCO INDUSTRY


Expansion of the tax base

It needs to be highlighted that cigarettes constitute a mere 20% of tobacco consumption in India by weight, and that fewer than 15% of the 200 million tobacco users consume cigarettes. Yet these 15% contribute nearly 90% of the revenues to the Exchequer from the tobacco sector. This form of consumption, apart from constituting practically the entire tax base of the tobacco sector, also supports export of cigarette tobaccos which contribute nearly Rs. 1,000 crores in foreign exchange earnings annually. Although tobacco consumers in India aspire to upgrade consumption to the cigarette format in line with international trends, the punitive taxation regime both at the Central and State levels has made it unaffordable to the majority of tobacco consumers, thereby keeping the tax base narrow and much below its natural potential. This has also resulted in the sub-optimisation of rural incomes and foreign exchange earnings from this sector.

An initiative towards expanding the tax base was taken in 1994 by reducing the excise duty on the micro segment from Rs. 120 to Rs. 60 per 1000. Resultantly, the tax base was expanded, with the micro segment growing from a level of 600 million cigarettes per annum to nearly 23 billion cigarettes in 1997-98. Over time the micro segment has come to be taxed at much higher rates, both at Central and Stage levels, which has now brought about a major decline in this segment. The year under review witnessed an erosion of about 13% in this segment. Although this segment carries lower margins and has thus not materially impacted the financial results of your Company, the adverse impact on the growth prospects of the tax base is undesirable.

The government needs to moderate the approach to this potentially high growth segment in line with the stability provided to the other segments in the last Budget. It is to be noted that the elasticity of revenues to the Exchequer would be visible over time and would require a patient adherence to the policy of moderation in taxes.

The menace of contraband cigarettes

High rates of taxation, particularly at the upper end, have spawned a flourishing trade in smuggled cigarettes. Recent conservative estimates indicate that smuggling in cigarettes is causing and unaccounted outflow of foreign exchange upward of Rs. 500 crores and the related loss of revenue to the Exchequer that would otherwise accrue on equivalent domestic manufacture. This contraband trade is estimated to be growing at an alarmingly high rate upwards 20% per annum.

The menace of contraband cigarettes is well recognised the world over. Since tax is avoided in the exporting country and evaded in the consuming country, given the high tax regime, smuggling of cigarettes has become lucrative and appears to be highly organised. The policy framework related to the tobacco industry needs to take into account the growing menace of smuggled cigarettes and the resultant tax export which is detrimental to the Indian economy.

There are a number of avenues that can facilitate the flow of contraband cigarettes into India. The legal framework related to the import of duty free cigarettes needs to be reviewed as these legal channels provide the opportunity to be used as a cover for supply to the contraband channel. The legal channels that carry such risk of misuse are : the duty free import under the Baggage Rules, duty free shops at international airports, the duty free imports by agents on behalf of embassies and naval ships, and duty free import of cigarettes for re-export. There are hardly any retails shops in the metropolitan cities of Mumbai, Calcutta, Chennai and Delhi where contraband cigarettes are not openly displayed and sold in large numbers. The recent announcement towards liberalisation of trade among SAARC countries has exacerbated this menace and provided another channel of entry of contraband into the Indian market. The promotion of international brands in India coupled with the absence of a harmonised tax regime among the SAARC countries, constitutes a very real threat of accelerated growth in contraband flow and consumption.

As an illustration, the excise duties in Nepal on king size cigarettes are one third of that obtaining in India. The import of international brands of cigarettes is also permitted in Nepal at attractively low rates of customs duty. International cigarettes with Nepalese health warnings can be found in the Indian market in growing numbers. Thus opportunities have been created for illegal tax arbitrage, constituting a growing tax export and posing a serious threat to the domestic industry and the tax base of the Exchequer from the tobacco sector.

I would make a strong plea that the ramifications of this serious issue are examined by the various arms of the government in conjunction with the tobacco industry in India with the objective of refurbishing the policy framework. It is evident that a combination of moderation in taxes, harmonisation of the tax regime among SAARC countries, plugging of the loopholes related to tax free imports and the strengthening of the enforcement machinery would go a long way in minimising the injury caused by such illegal trade in cigarettes.

On an experimental basis, your Company would be willing to contribute to the cost of strengthening the enforcement measures. This experiment can begin in the metropolitan cities of the country, whereby the seized contraband cigarettes are destroyed thus creating disincentives for the retail trade. The industry forums, with your Company's support, are in the process of making comprehensive and detailed recommendations to the government in this regard and on other measures related to the tobacco industry.

       CONCLUSION


Your Company is a leading Indian enterprise. It has the wherewithal to significantly enhance its contribution to the Indian economy. Over time it can become a major player of international dimensions and create growing value for its shareholders. The ITC Group currently represents a pool of high calibre human resource comprising 2,400 managers, 13,700 employees and an asset base of Rs. 4,700 crores. Although your Company ranks high in terms of market capitalisation among Indian companies, and its size of operations in India is significant, it is still a tiny enterprise when viewed in the international context.

The challenge of attaining international dimensions is at once humbling, inspiring and exciting. In the ultimate analysis, the cutting edge in the realisation of such an aspiration would be provided by the dynamism of its human resource. The secret of creating a winning corporation lies in the appreciation of the potential value of this human capital and in the ability of the distributed leadership within the company to nurture and mobilise such talent. I would like to acknowledge the contribution made by your Company's employees at all levels and seek your cooperation, as always, in support of their endeavour.

Before I continue with the agenda for today's business, I would like to, with your permission, pay a sincere tribute to the valour of the armed forces of our country who fought so bravely to preserve the territorial integrity of our secular nation. I would now request you to join me in observing a brief silence in the memory of those who made the ultimate sacrifice for this cause.

© ITC Limited