Analysis: Godfrey Phillips India Ltd

The current section of the “Analysis” series covers Godfrey Phillips India Ltd, India’s second-largest tobacco company making Marlboro cigarettes and owning brands like Four Square, Red & White, Jaisalmer etc.

“Analysis” series is an attempt to share with all the readers, our inputs to the company analysis submitted by readers on the “Ask Your Queries” section of our website.

Please note that to benefit the maximum from this article; an investor should focus on the process of analysis instead of looking for good or bad aspects of the company. She should learn the interpretation of different types of data and transactions and pay attention to the parts of annual reports etc. used to get the information. This will help her in improving her stock analysis skills.

Godfrey Phillips India Ltd: Detailed Fundamental Analysis

Godfrey Phillips India Ltd publishes both standalone as well as consolidated financials because, on Sept 30, 2022, it has six subsidiaries and three associate companies.

Q2-FY2023 results, page 11:

Investment in subsidiaries:

• International Tobacco Company Limited (100.00% stake)
• Chase Investments Limited (100.00% stake)
• Friendly Reality Projects Limited (92.20% stake)
• Unique Space Developers Limited (66.67% stake)
• Rajputana Infrastructure Corporate Limited (92.20% stake)

Investment in associates:

• IPM India Wholesale Trading Private Limited (24.80% stake)
• KKM Management Centre Private Limited (36.75% stake)
• KKM Management Centre Middle East (FZC) (36.00% stake)

We believe that while analysing any company, an investor should always look at the company as a whole and focus on financials, which represent the business picture of the entire company including its subsidiaries, joint ventures, associates etc. The consolidated financials of a company present such a picture.

Further advised reading: Standalone vs Consolidated Financials: A Complete Guide

Therefore, in the case of Godfrey Phillips India Ltd, during the last 10 years (FY2013-FY2022), we have analysed consolidated financials.

With this background, let us analyse the financial performance of Godfrey Phillips India Ltd.

Financial and Business Analysis of Godfrey Phillips India Ltd:

Sales of Godfrey Phillips India Ltd have grown at a pace of 3% year on year from ₹2,096 cr in FY2013 to ₹2,688 cr in FY2022. Further, sales have increased to ₹3,277 cr in the last 12 months ended September 2022 i.e. Oct. 2021-Sept. 2022). During the last 10 years, Godfrey Phillips India Ltd has seen volatility in its business performance and its sales have seen multiple periods of decline.

In FY2016, sales of Godfrey Phillips India Ltd declined to ₹2,331 cr from ₹2,586 cr in FY2015. In FY2018, sales of the company declined to ₹2,326 cr from ₹2,403 cr in FY2017. Recently, in FY2021, the sales of the company declined to ₹2,525 cr from ₹2,877 cr in FY2020.

On an overall basis, the operating profit margin (OPM) of the company improved from 16% in FY2013 to 24% in FY2022 and in the last 12 months ended September 2022 i.e. Oct. 2021-Sept. 2022). During this period, in the initial half (FY2013-FY2017), OPM declined from 16% in FY2013 to 11% in FY2017. Thereafter, from FY2018 onwards, the OPM started increasing and reached 24% in the last 12 months ended September 2022 i.e. Oct. 2021-Sept. 2022).

The net profit margin (NPM) of Godfrey Phillips India Ltd had seen a remarkable change during the last 10 years (FY2013-FY2022). NPM has more than doubled during this period from 8% in FY2013 to 17% in the last 12 months ended September 2022 i.e. Oct. 2021-Sept. 2022).

To understand the reasons for such a financial performance of Godfrey Phillips India Ltd, an investor needs to read the publicly available documents of the company like its annual reports from FY1998 onwards, credit rating reports by CRISIL, corporate announcements as well as other public documents. Then she would understand the factors leading to an overall increase in its sales and profit margins over the years with fluctuations in between.

The above-mentioned documents indicate that the following key factors influence the business of Godfrey Phillips India Ltd, which are critical to understand for any investor analysing the company.

1) Excessive regulatory control on cigarettes and other tobacco products:

Consuming tobacco is an addiction. As a result, govt. has put strict controls on almost every aspect of its trade like other addictive substances e.g. alcohol, drugs etc. Govt. has strict regulations about tobacco cultivation, import, export, processing, cigarette production, marketing, advertising, labelling, packaging and sales etc.

The main aim behind such controls is to restrict the prevalence of tobacco consumption and prevent its harmful impact on society in terms of both health and social issues.

As a result, companies operating in cigarette production usually do not have a free hand to grow their business through aggressive marketing and sales techniques.

Moreover, over the years, these govt. regulations have become stricter.

1.1) Restrictions on the sale and consumption of tobacco products:

In addition to regular campaigns to spread awareness against smoking, in 2003, govt. banned the sale of tobacco products within 100m of educational institutions. At that point, Godfrey Phillips India Ltd complained that this ban would affect the lives of small retailers.

FY2003 annual report, page 14:

The imposition of a ban on tobacco sales within 100 yards of educational institutions will create significant dislocation and affect the livelihood of small retailers in India’s densely populated environment, and needs to be rethought.

Thereafter, in 2008, the Indian govt. banned smoking in all public places.

FY2009 annual report, page 3:

Similarly, the Prohibition of Smoking in Public Places Rules, came into effect on October 02, 2008 under which smoking has been banned in public places including work places, shopping malls, cinema halls and public buildings.

The ban on smoking in public places led to a decline in cigarette consumption.

FY2009 annual report, page 4:

imposition of smoking ban effective October 2008 resulted in a decline in consumption of premium hand rolled cigars in Five Star Hotels, Pubs and Restaurants.

At times, the govt. banned the sale of tobacco products like gutkha in FY2013.

FY2013 annual report, page 7:

Gutkha, a form of smokeless tobacco has been banned under the food laws by almost all the States across India. But the Gutkha manufacturers are litigating against the ban.

In addition, the govt. has also banned the sale of tobacco products to customers below 18 years of age.

1.2) Restrictions on advertising by tobacco companies:

To restrict the exposure of consumers to tobacco products, in 2003, Govt. of India put strong limitations on advertising and marketing by tobacco companies.

At that point, Godfrey Phillips India Ltd complained that these regulations put domestic cigarette producers at a disadvantage over international players.

FY2003 annual report, page 14:

Cigarette and Tobacco Product Act imposes further advertising and marketing restrictions, additional health warnings and product labeling which will adversely affect domestic cigarette brands against international brands whose promotion and marketing will still be seen on cable TV, international magazines and on neighbouring country TV.

Until now, the limitations were primarily on advertising in the mainstream media. Whereas in 2004, the govt. put limitations on the advertising by tobacco companies in retail shops (points of sale) as well.

FY2004 annual report, page 16:

From May 1, 2004, stringent restrictions on advertising of tobacco products even at the point-of-sale came into force.

Advised Reading: How to do Business Analysis of FMCG Companies

1.3) Health warning on the packaging of cigarettes:

To dissuade the public from consuming tobacco products and to educate them about their harmful effects on health, govt. has mandated that packets of all tobacco products should have health warnings. Over time, regulations have made the warning messages stronger.

Initially, companies had to print warning messages as smoking kills and smoking is injurious to health. However, in 2009, companies had to show pictorial warnings showing lung damage caused by smoking.

FY2009 annual report, page 3:

…Cigarettes and Other Tobacco Products (Packaging & Labelling) Rules, 2008, has mandated the tobacco industry to print the prescribed graphic health warnings on its product packages. These regulations have come into force from May 31, 2009.

In 2011, to keep the warning messages effective, the Govt. issued new warning pictures and mandated that the warning messages on the packs should be rotated every two years so that consumers do not ignore the pictorial warning messages.

FY2011 annual report, page 4:

Government of India, notified…specified health warnings on tobacco packs shall be rotated every two years. New graphic health warnings have been issued on May 27, 2011

Originally, the warning pictures were required to cover 40% of one side of the cigarette packets. However, in FY2016, the govt. made the requirement stringent. Now, the pictorial warning messages were required to cover 85% of both sides of the cigarette packs. In addition, the warning picture was changed from a damaged lung to those showing mouth cancer.

FY2016 annual report, page 6:

most recently implemented regulation is the 85 per cent graphic health warning (GHW) on both sides of the cigarette package from earlier 40% on one side of the package and substituted the earlier pictures with more gruesome ones.

As per the company, the requirement of gruesome pictures covering 85% of both sides of a cigarette pack is one of the most stringent across the world.

FY2021 annual report, page 7:

With 85% coverage, India has one of the largest pictorial warning size on the packs in the world when compared with global average of 40%.

However, the govt. believes that these warning messages are still not having the desired impact of reducing cigarette consumption in the population. One of the reasons is that in India, a lot of cigarette sales take place in the form of single cigarette sticks instead of packs. In such cases, the consumer does not get to see the warning message because the seller hands out a single cigarette from the pack to the consumers.

Therefore, to counter this behaviour, the govt. is considering a ban on the sale of loose cigarettes.

FY2015 annual report, page 7:

government is contemplating ban on sale of loose cigarettes.

However, the cigarette lobby is trying hard to prevent such measures. As a result, despite efforts of the anti-smoking activists, the ban on the sale of loose cigarettes is still in the works. Nevertheless, anti-smoking activists are continuously putting pressure on the govt. to put strict measures to control the smoking issue in society.

Recently, the demand for the sale of loose cigarettes as well as abolishing smoking zones in public places is gaining strength.

India may soon ban sale of loose cigarettes, smoking zones at airports may go: WION, December 13, 2022

1.4) No more approvals to increasing cigarette-manufacturing capacities:

In its efforts to restrict the consumption of tobacco products, the govt. of India has put cigarettes under the sector for compulsory licensing. In addition, the govt is no longer giving any approvals to increase the manufacturing capacity of cigarettes in the country. (Source).

Cigarette advertsing is banned in India and the government doesn’t allow companies to increase capacities for manufacturing cigarettes.

1.5) No foreign direct investment in cigarette manufacturing:

To reduce tobacco consumption in the country, the govt. of India has undertaken many steps to restrict the production of cigarettes in the country. In addition to blocking any attempt by cigarette manufacturers to increase production capacity, the govt. has also stopped access to foreign direct investment (FDI) by the players in the cigarette-manufacturing sector (Source: Reuters).

India in 2010 prohibited foreign direct investment in cigarette manufacturing, saying this would enhance efforts to curb smoking.

The ban on FDI restricts cigarette manufacturers’ access to capital to sustain or grow their businesses. There have been multiple instances in India when the govt. has blocked the attempts of foreign tobacco manufacturers from investing money in India.

In the past, Japan Tobacco Inc. had to close down its joint venture in India when its application to bring in more FDI was rejected in 2010 (Source: Japan Tobacco’s Indian JV goes up in smoke: Business Standard, January 21, 2013).

Confronted with a stringent FDI regime in tobacco, the world’s third largest publicly traded tobacco company, Japan Tobacco Inc, is closing its joint venture in India from December 31. The venture, JT International Indian Pvt Ltd, has already surrendered its licence to manufacture five billion cigarettes per annum to the government.

Japan Tobacco has made several attempts to increase its stake in the Indian company from 50 per cent to 74 per cent and bring in $100 million to address its growing losses. However, with the ban on FDI in tobacco, its hopes to be a player of note in the Indian market ended. Its application was rejected in 2010.

As per the same article, Govt. of India did not approve the investment of British American Tobacco Ltd in ITC.

British American Tobacco had, in the recent past, made an unsuccessful attempt to increase its shareholding in ITC Ltd.

Even in the case of Godfrey Phillips India Ltd, the Indian govt. is investigating whether it along with its partner Philip Morris allegedly bypassed the FDI regulations while entering into a contract manufacturing arrangement to produce Marlboro cigarettes. (Source: Exclusive: India investigating Philip Morris, Godfrey Phillips: Reuters)

Philip Morris has for years paid manufacturing costs to Godfrey Phillips to make its Marlboro cigarettes, circumventing a nine-year-old government ban on foreign direct investment in the industry, Reuters reported based on a review of dozens of internal company documents, which were dated between May 2009 and January 2018

Godfrey Phillips India Ltd has also highlighted this investigation to its shareholders in its FY2019 annual report, page 200:

Subsequent to the year end, the Holding Company has recently been called upon by the Directorate of Enforcement (‘ED’) seeking certain information including those in connection with the business arrangements with IPM India Wholesale Trading Pvt. Ltd.,(IPM) an associate of the Holding Company.

These steps by the govt. of India indicate that the govt. is serious about limiting the expansion of tobacco and cigarettes within the country.

Even if tobacco companies are making losses and need an infusion of capital to survive, still, the govt. does not allow them to raise money from foreign partners even risking the closure of their business. In the case of Japan Tobacco Inc., the govt. caught it when it attempted to circumvent FDI regulations by way of offering shares to Indian promoters and foreign promoters at different prices. (Source: Japan Tobacco’s Indian JV goes up in smoke: Business Standard, January 21, 2013).

The Indian JV also came under government scrutiny for bringing in money through the back door by issuing fresh equity of a face value of Rs 1 each to Japan Tobacco, the parent, but at a premium of Rs 298 a share, aggregating Rs 293 crore. It also issued an equal number of shares to the Indian partner, but at par, which meant it paid only Rs 1 crore…That way, Japan Tobacco was able to bring in the required money, but without changing the equity structure.

Ultimately, the Japanese JV had to shut down operations.

Going ahead, an investor should always keep in her mind that if any tobacco manufacturer faced financial issues, then govt. will not make it easy for the company to raise money. The company may have to shut down its operations.

1.6) Govt. regulations about growing tobacco in India:

In India, the govt. does not promote tobacco cultivation actively to increase production. There have been times when the industry could not get a sufficient quantity of raw tobacco because the govt. had put a “crop holiday” on tobacco.

As per Godfrey Phillips India Ltd in FY2001, the company faced challenges in sourcing raw tobacco because the Govt. of Andhra Pradesh had declared a “crop holiday” on tobacco in the state in the year. As a result, the exports of the company were impacted.

FY2001 annual report, page 14:

We have taken some fresh initiatives…in spite of no flue cured tobacco, having been grown in Andhra Pradesh this year due to ‘Crop Holiday’ declared by the Government

Once again, in FY2016, the business of the company was impacted when tobacco cultivation happened in a smaller area than expected.

FY2016 annual report, page 8:

Reduced crop size in Karnataka from where we do have a significant volume has impacted performance in unmanufactured tobacco exports.

As per Godfrey Phillips India Ltd, tobacco cultivation is drought resistant, is well suited for Indian climatic conditions, and has the potential to increase the earnings of farmers.

FY2022 annual report, page 6:

Tobacco farming is drought tolerant, hardy and short duration crop

Moreover, Indian raw tobacco is cheaper than foreign production, which puts India at an advantage.

FY2007 annual report, pages 9, 11:

exportable variety of tobacco – Flue Cured Virginia (which is used in cigarettes), accounts for only 35% of the total Indian production of tobacco…Indian FCV tobacco is amongst the cheapest in the world market.

However, despite the favourable climate, India grows tobacco only on about 0.25% of the cultivation area as compared to 1% of the area in other major countries like China and Zimbabwe.

FY2017 annual report, page 6:

Global leading tobacco producers like Malawi, China and Zimbabwe have more than 1% of their arable landmass under tobacco cultivation, while India has only around 0.25% of land under tobacco cultivation

Therefore, India is attempting to restrict the growth of the tobacco industry by not promoting tobacco cultivation among the farmers despite favourable climatic conditions.

However, despite these measures, over the years, tobacco consumption in India has increased. This is primarily because smoking is an addiction where only educating society is not sufficient.

As a result, the govt. continues to take other economic steps as well by increasing taxes on all tobacco products including cigarettes so that such products become expensive and the public faces constraints in purchasing them.

Advised reading: How to do Business Analysis of a Company

2) High taxes on tobacco products especially cigarettes:

Increasing taxes to make tobacco products unaffordable is one of the strategies adopted by almost all countries across the globe. Even in India, the govt. has consistently increased the taxes on all tobacco products including cigarettes.

Year after year, both central govt. as well as state govts. have increased taxes on tobacco products within their jurisdiction. Previously, in the case of cigarettes, the central govt. used to increase excise duty while the state govts. used to increase luxury tax, entry tax, value-added tax (VAT) etc.

The extent of taxes on the tobacco industry has been high for a long time. As per the FY1998 annual report, the tobacco industry contributed almost 10% of the entire excise revenue of India.

FY1998 annual report, page 10:

It contributes Rs. 56,000 crores to the country’s GNP and about Rs. 5,800 crores of excise revenue, which is about 10% of the total Central Excise revenue of the country…The high rate of taxation is the most important factor that impedes the growth of the cigarette industry.

Despite already high taxes, the govt has continuously increased excise duty as well as other taxes like VAT and entry taxes year on year.

FY1998 annual report, page 10:

As a result of increase in the excise rates by nearly 15.5% last year, the industry growth began stagnating…Government this year has again increased the tax rate by about 9.5%

Subsequently, the govt. again increased the excise duty in FY2000 (5%), FY2002 (15%), FY2005 (10%), FY2007 (6%), FY2009 (142% to 387% on non-filter cigarettes), FY2010 (18%), FY2012 (22%), FY2013 (18%), FY2014 (11-72%), FY2015 (12-22%), and FY2016 (10%).

Apart from the excise duty increase by the central govt., the state govts. have increased their share of taxes by increasing taxes like value-added tax (VAT), luxury tax, entry tax etc.

In FY2017, when state govts. put 12.5% VAT on the sale of cigarettes, then along with the excise duty hikes, the tax increase totalled about 30%.

FY2007 annual report, page 9:

an additional 6% excise duty levied for the second year in a row. In addition, 12.5% VAT is levied by the States on invoice price. The combined effect of both is equivalent to around 30% increase in tax incidence on cigarettes.

In FY2009, different state govts. increased the rate of VAT on cigarettes to 20%.

FY2009 annual report, page 16:

Governments of Delhi, Maharashtra and Rajasthan have increased the rate of VAT on tobacco to 20%

In FY2011, many states again increased VAT to 40% of the invoice value.

FY2011 annual report, page 4:

In India many of the States have effected steep rise in the rates of VAT. Current rates of VAT on cigarette in India vary between 12.5% to 40%.

In fact, whenever any govt. faces revenue shortfall, then tobacco products are one of the first segments where they increase the taxes to enhance their revenue. In the next year, FY2012, some states increased VAT on cigarettes to 50%.

FY2012 annual report, page 7:

more and more States resorting to tax tobacco products to bridge the revenue shortfall. And as an impact of that, VAT rates in India on cigarettes now vary from 12.5% to 50%

In FY2013, some states increased VAT on cigarettes to 65%.

FY2013 annual report, page 7:

States resorting to tax tobacco products to bridge the revenue shortfall. And as an impact of that, VAT rates in India on cigarettes now vary from 12.5% to 65%.

In fact, over FY2015 to FY2014, the incidence of VAT on cigarettes had increased by more than 50% i.e. from previously 28% of the invoice value to 43% in FY2015.

Share of VAT within total taxes to the cigarettes industry, has increased from 28 per cent in 2010-11 to 43 per cent in 2014-15.

States also resorted to levying taxes like entry tax and octroi on tobacco products.

FY2000 annual report, page 12:

the state of Rajasthan introduced an additional levy of entry tax at the rate of 1.5%.

Some states even put a luxury tax on cigarettes, which later on, as decided by Hon. Supreme Court, they did not have the power to levy. (Source: Go smoke that: Financial Express, Jan 24 2005)

Cigarette and gutka companies may be tempted to rejoice at Thursdays Supreme Court ruling that states have no power to impose luxury tax on cigarettes and gutka.

In addition, the govt. put a high customs duty on the import of tobacco products.

FY2009, page 4:

The Government imposed 100% increase in the import duty for cigars in the Budget for 2008-09 which had adverse impact on its sale

A sharp increase in taxes on tobacco products has had the desired impact because, for many years, it had led to a decline in the sales and profit margins of cigarette manufacturers like Godfrey Phillips India Ltd.

The sharpest impact of an increase in excise duty on the sales of cigarettes was seen in FY2009 when govt. increased excise duty on non-filter cigarettes by 142% to 387%. As a result, the entire non-filter cigarette segment was wiped out.

FY2009 annual report page 2:

Unprecedented increase in excise duty on non-filter cigarettes in the Budget for 2008-09 has virtually wiped out the non-filter segment which nearly constituted 30% of the cigarette market.

In other periods also, even though the increase in excise duty was less steep; however, it led to a decline in the sales for the industry.

In FY2001, Godfrey Phillips India Ltd intimated to its shareholders that due to a sharp increase in excise duty, the sales of the entire industry had been declining in the previous three years.

FY2001 annual report, page 13:

The total volume of domestic cigarette industry has been declining continuously for the last three years.

In FY2002, when the govt. sharply increased the taxes, then the sales of the cigarette industry declined by 12%.

FY2002 annual report, page 11:

The domestic cigarette industry witnessed one of the sharpest declines in the sales volume in the last year when it lost more than 12% of its size as a result of steep hike in the rate of excise duty, as much as 15% across all segments.

In FY2005 as well as FY2006, Godfrey Phillips India Ltd had to absorb the impact of the increase in taxes, as it could not increase the prices of cigarettes fearing a decline in sales. As a result, in FY2006, the company witnessed a decline in its profit margins.

FY2006 annual report, page 3:

Inspite of the substantial increase of 10% in excise duty in 2005 Budget no major changes were effected by the Company on its cigarette prices.

In FY2011, the sales of the cigarette industry declined in India.

FY2011 annual report, page 3:

India too had a decline of 1.2% in volumes in FY 2010-11.

In FY2012 and FY2013, the profit margins of the company declined because of a sharp increase in the excise duty, which it could not pass on to the customers.

FY2013 annual report, page 10:

The continuous increase in taxation on cigarette over the last several years has been adversely affecting the volumes and therefore, impacting profitability.

Once again, in FY2015, the cigarette industry along with Godfrey Phillips India Ltd witnessed a decline in volumes due to an increase in taxes.

FY2015 annual report, page 7:

The domestic cigarette industry continues to reel under pressure of increased indirect taxes with volumes declining by over 9% in 2014-15…your Company has witnessed decline in volume,

In FY2016, the company witnessed a decline in sales because, due to an increase in excise duty, when it increased cigarette prices, then the customers shifted from premium cigarettes (length of 69 mm or more) to cheaper cigarette segment (length 64 mm or less).

As a result, Godfrey Phillips India Ltd decided that it would focus more on the economical segment of cigarettes.

FY2016 annual report, page 7:

Continued tax increases forced your Company to increase the price of its popular brands which has resulted in consumer churn, part of which is gained by economy segment of 64mm brands…Growth for the Company will be pursued through the brands placed at economical price points

In the cigarette industry, the 64 mm segment has a lower profit margin than the premium segment of 69 mm.

FY2014 annual report, page 7:

the lower margin 64mm and the higher margin 69mm segments.

Higher sales of economical (cheaper) cigarettes (length 64 mm or less) resulted in a decline in operating profit margins (OPM) of Godfrey Phillips India Ltd in FY2017 to 11% from 14% in FY2016.

Therefore, there have been periods when an increase in taxes by the govt. has had a direct impact on the sales and profit margins of tobacco players including cigarette manufacturers.

2.1) Cigarettes have the highest taxes out of all tobacco products:

As per Godfrey Phillips India Ltd, when compared to other tobacco products, the taxes on cigarettes are the highest.

The taxes on cigarettes are so high that even though cigarettes constitute only about 9% of the overall tobacco consumption in India, still, they contribute about 80% of the overall tax collection from the entire tobacco industry.

FY2021 annual report, page 6:

Only 9% of tobacco consumed in India constitute legal cigarettes, while 91% are from traditional products and illicit cigarettes. This 9% contributes to 80% of the taxes collected from the industry by the Government of India.

Over the years, despite being the tobacco product with the highest taxes, cigarettes as a category have seen the highest further increase in taxes. As a result, the share of cigarettes in overall tobacco consumption has consistently gone down.

As per the FY2004 annual report of Godfrey Phillips India Ltd, page 15, the share of legal cigarettes in total tobacco consumption used to be about 14% in FY2004 and 23% in FY1973

Small and declining share of Tobacco market: In India only 14% of tobacco consumption happens through cigarettes and the balance 86% is consumed through bidis, snuff, and chewing tobaccos like gutka, khaini and zarda. Moreover, this share has been steadily declining (from 23% in 1971-72).

As per the FY2015 annual report of Godfrey Phillips India Ltd, page 6, the share of legal cigarettes in total tobacco consumption used to be about 12% in FY2015.

As per Godfrey Phillips India Ltd, cigarettes used to constitute about 21% of the overall tobacco consumption in India in FY1982, which has now decreased to 8-9% of the overall tobacco consumption in FY2021.

FY2022 annual report, page 7:

share of legal cigarette has declined from 21% in 1981-82 to 8% in 2020-21 despite 50% increase in tobacco consumption in India,

It indicates that the decline in the share of cigarette consumption is a consistent one over the years from 1972 (23%), 1982 (21%), 2004 (14%), 2015 (12%) to 2021 (8-9%).

This above disclosure also highlights that the policy of govt. to put high taxes on tobacco products has had the desired impact of limiting the growth of the tobacco industry over the years. As per the above statement, despite a huge increase in the size of the economy as well as the population in the last 40 years, the size of the tobacco industry has only grown by a total of 50% from FY1982 to FY2021, which is an annualized growth rate of about 1.01%.

On multiple occasions, Godfrey Phillips India Ltd had highlighted to its investors the tough business environment created by the govt. to the cigarettes industry. The industry is not able to grow its volumes significantly even over long periods. High taxes are leading to customers shifting away from cigarettes. However, even in the face of appeals by the industry, the govt. further increases the taxes.

FY2000 annual report, page 8:

The indifferent attitude and short- sighted policies of the Government continue to impede the natural growth of the Industry which remains stagnant almost at the same level it was some 15 years ago. As a matter of fact, in the year 1999-2000, the Industry lost a volume of 4- 5% over the previous year. In spite of the declining trend and against the plea the Industry made, the government again raised the rates of excise duty this year by nearly 5%.

Currently, the share of taxes in the cigarette segment is about 52% of the retail price. However, as per WHO recommendations, to control tobacco consumption, countries should target a tax rate of 75% of the retail price for all tobacco products. Therefore, there are continuous agitations from anti-smoking activists to further increase taxes on cigarettes. (Source: Public health groups, doctors urge govt to hike excise duty on tobacco products in next Union Budget: Economic Times, Dec. 12, 2021).

The total tax burden (taxes as a percentage of final tax-inclusive retail price) is only about 52.7 per cent for cigarettes, 22 per cent for bidis and 63.8 per cent for smokeless tobacco. This is much lower than the World Health Organization (WHO) recommended tax burden of at least 75 per cent of retail price for all tobacco products, John said.

Advised reading: How to do Financial Analysis of a Company

3) Cigarette producers do not have unlimited pricing power:

The above discussion also proves the popular perception wrong that smoking cigarettes is such an addiction that an addict will smoke cigarettes even if the price increases significantly. In fact, the demand for cigarettes is not unlimited or unrestricted.

Though there have been times when the cigarette could increase its revenue and profit margins despite a decline in the sales volume because it could increase cigarette prices like in FY2013 when the revenue of the industry grew by 20% despite a 2% decline in sales volume indicating that the industry had increased its prices significantly.

FY2013 annual report, page 6:

Indian cigarette market has shown a decline of around 2% in volume and a growth of 20% in terms of value over the previous year.

In FY2014 as well, the cigarette industry could increase its revenue by

FY2014 annual report, page 6:

Indian cigarette market has shown a decline of around 3 per cent in volume, impacted by pricing pressure and growing health concerns. However, the price hikes taken by the industry have resulted in a value growth of 14 per cent over the previous year.

In FY2015, Godfrey Phillips India Ltd could increase its revenue by 4.2% despite a decline in sales volume because it could increase the prices of cigarettes.

FY2015 annual report, page 7:

Though your Company has witnessed decline in volume, it still was able to register a growth of 4.2% in terms of operating revenue from Rs. 3263 crore in previous year to Rs. 3400 crore.

However, there have been times when cigarette manufacturers could not pass on the increase in taxes and input costs to the customers because they knew that beyond a limit, the customer would not be willing to pay a high price.

For example in FY2009, the profit margins of Godfrey Phillips India Ltd declined because it could not pass on the increase in costs to its customers.

FY2009 annual report, page 5:

significant cost increases resulting from unprecedented hike in excise duty on non-filter cigarettes in 2008-09 budget, increase in tobacco prices in 2008 Andhra and Karnataka crops by 60~70% over last year…All these factors cumulatively have affected the operating margins adversely.

The company faced a similar situation in FY2017 and FY2018 when due to a high increase in taxes, it could not increase the prices of its premium products (69 mm or more) and it had to focus on low-margin cheaper products (64 mm or less). It resulted in a decline in the OPM of the company to 11% in FY2017 and FY2018 from 14% in FY2016.

Godfrey Phillips India Ltd had to suffer a decline in its business performance because it faces intense competition from other cigarette producers (both domestic and international) as well as from other sources like illegal and smuggled cigarettes as well as from other tobacco products like bidi, gutkha etc.

4) Intense competition in the cigarette industry:

The cigarette industry faces intense competition from multiple sources.

4.1) ITC Ltd:

In the Indian cigarette market, ITC Ltd is the market leader. As per the credit rating report of ITC Ltd by ICRA, Nov. 2021, it has about 80% share of the organized domestic cigarettes market.

ITC is the market leader in the organised domestic cigarette industry, with a market share of about 80%.

When an industry has such a large market leader, then other minor players like Godfrey Phillips India Ltd (11-12% market share) have to take pricing decisions by keeping in mind the pricing strategy of ITC Ltd; otherwise, they risk losing their market share to ITC Ltd. Therefore, Godfrey Phillips India Ltd cannot increase the prices of its cigarettes at will.

The company acknowledged the force of ITC Ltd in its annual report for FY2002, page 7:

Your company continues to face formidable challenges not only from the daunting dominant rival ITC Ltd. but also from the invasion of a spate of cheap smuggled cigarettes entering the country from neighbouring countries.

4.2) Illegal cigarettes:

At the same time, the cigarette industry faces competition from the illegal cigarettes market, which as per the company, constitutes almost 25% of the entire cigarette sales in India.

FY2021 annual report, page 7:

illegal cigarette trade has increased significantly and now accounts for roughly 1/4th of the total cigarette market in India.

Illegal cigarettes come primarily from two sources; the first of which is smuggling from neighbouring countries.

Due to very high taxes on cigarettes in India, smuggled cigarettes, which evade all these taxes, are available at a very cheap price. In addition, these cigarettes offer very high-profit margins to retailers, who attempt to give a preference to these cigarettes while selling to customers.

As per the data disclosed by Godfrey Phillips India Ltd in its FY2002 annual report, smuggled illegal cigarettes are available in the market for approximately 60-80% lower price than legal domestic cigarettes. As per the company, a packet of smuggled cigarettes is available in the market for about ₹5-10/- whereas the packet for legal cigarettes sells for about ₹29-30/- (about ₹15 invoice value + ₹14.5 excise duty).

FY2002 annual report, page 11:

The sharp increase in cigarette prices triggered an unprecedented supply of cheap smuggled cigarettes in abundance from neighboring countries. Most of them were in king size filter format selling in the market for Rs. 5 to Rs. 10 for a packet of 10 cigarettes while domestic excise duty alone works out to Rs. 14.50 for a pack of 10 sticks. Since the smuggled cigarettes offer very high margin for traders, there is a natural inducement for them to push these products.

As per Godfrey Phillips India Ltd, the second source of illegal supply of cigarettes comes from many Indian producers who play around with the rules and produce cigarettes without taking the mandatory license for cigarette production.

As per the company, those players who manufacture cigarettes in small plants with less than 50 employees do not need to take a license. Therefore, many players register many small firms and show less than 50 employees in each firm to avoid taking a license and in turn, produce and sell cigarettes in the market.

FY2004 annual report, page 16:

unlicensed manufacture of cigarettes. Many small operators with less than 50 persons in direct employment are undertaking cigarette manufacturing by merely obtaining State permission. This breaches the compulsory cigarette manufacturing licensing required under the ID&R Act, 1951 and is likely to lead to revenue leakages. It also creates undesirable unlicensed capacity, when only 50% of the current licensed capacity is utilised

Such production is an issue because of two reasons; first, it creates unmonitored, unlicensed capacity in the country when already the organized players have a lot of underutilized production capacity. In addition, such players also bypass the condition that the govt. is not giving approvals for any additional cigarette manufacturing capacity in the country.

4.3) Competition from other tobacco products:

Cigarettes have much higher taxes when compared to other tobacco products like bidi and gutkha. As per some estimates, taxes form about 52.7% of the retail price for cigarettes whereas they form only about 22% for bidi (Source).

As a result, whenever the prices of cigarettes increase beyond a point, many customers switch from smoking cigarettes to bidis.

FY2017 annual report, page 7:

legal cigarette industry faced yet another challenging year. On one hand, it faces competition from lightly taxed tobacco products like bidis, chewing tobacco, gutkha, etc.; on the other hand, the illicit cigarette market continues to grow unabated.

As per Godfrey Phillips India Ltd, high taxes on cigarettes are effectively subsidizing lightly taxed products like bidi.

FY2003 annual report, page 14:

The prohibitive and discriminatory tax on cigarettes acts as an effective subsidy to the non-cigarette tobacco industry including bidis and chewing tobacco.

There is no surprise that the consumption of cigarettes in India is one of the lowest and the consumption of products like bidi and gutkha is the highest in the world.

In India, cigarettes constitute about 8% of overall tobacco consumption whereas, in the remaining world, cigarettes constitute 90% of tobacco consumption.

FY2022 annual report, page 6:

In India, the legal cigarettes account for 8% of the total tobacco consumption and this is in complete contrast with rest of the world where 90% of the tobacco is in the form of cigarettes.

FY2003 annual report, page 15:

As a consequence, consumption on non-cigarette tobacco products including bidis and chewing tobacco has grown to be the highest in the world!

As a result, it does not come as a surprise to an investor when Godfrey Phillips India Ltd enters into both bidi and chewable tobacco segments.

In FY2010, the company entered the chewable tobacco segment by launching “Pan Vilas” pan masala.

FY2010 annual report, page 2:

After three years of extensive research on product development and consumer understanding, Godfrey Phillips India successfully test launched Pan Vilas in four key markets.

In FY2011, it entered the bidi market with “Sonna Bidi”.

FY2011 annual report, page 5:

SONNA BIDI: To fulfill its commitment to constantly seek out new opportunities, Godfrey Phillips India has forayed into the bidi market, which is estimated at Rs. I 2000 to 15000 Crores, with a production of 700 billion sticks per annum.

In FY2012, Godfrey Phillips India Ltd entered into the zarda segment with the brand “Swarn Vilas”.

FY2012 annual report, page 8:

Your Company also ventured in the difficult zarda segment with the brand “Swarn Vilas”.

Further advised reading: How to analyse New Companies in Unknown Industries?

5) Exposure to natural calamities and uncertainties in tobacco souring:

Tobacco cultivation faces all the challenges of the agricultural sector linked to natural calamities and disease. As a result, at times, Godfrey Phillips India Ltd has faced challenges in getting proper availability of good quality and sufficient quantity of tobacco.

For example, in FY1999, the tobacco crop suffered from heavy rains and disease. Therefore, the tobacco available in the market was of poor quality and very costly. As a result, exports of Godfrey Phillips India Ltd suffered, as foreign buyers did not buy tobacco from it.

FY1999 annual report, page 11:

The Flue Cured Virginia tobacco crop in Andhra, the main tobacco growing area of the Country suffered severely in 1998 due to heavy rains…the crop further suffered on account of brown spot disease which resulted in not only poor quality but also in a sharp decline in the estimated availability. Prices rose sharply. High price and poor quality made the foreign buyers shy away from the Indian market

Godfrey Phillips India Ltd faced similar challenges in FY2001 when due to adverse climatic conditions, the quality, as well as quantity of tobacco in the market, suffered. As a result, its regular overseas buyers did not buy tobacco from it.

FY2001 annual report, page 14:

Suffering from the climatic conditions, the quality of tobacco was very low and coupled with very high prices in the beginning of the season, our traditional buyers shied away from the Indian market

During FY2021, the operations of the company suffered significantly due to covid-19 pandemic-related lockdowns resulting in a decline in sales as well as profits.

Credit rating report by CRISIL, September 2021:

In fiscal 2021, revenues de-grew 13% due to the temporary closure of factories and distribution points on account of the lockdown imposed and also restrictions on movement mainly in the first half of fiscal 2021.

Advised Reading: Credit Rating Reports: A Complete Guide for Stock Investors

6) Major increase in profit margins of the company is due to cost-cutting and better-operating efficiency:

Over the years, Godfrey Phillips India Ltd has taken many steps to cut its costs, and improve its operating efficiency to increase the profitability of its operations.

In FY2000, the company reduced its workforce significantly by 26% by offering a voluntary retirement scheme to its employees.

FY2000 annual report, page 12:

The Company succeeded in rationalising its work force in its factories at Mumbai as well as Ghaziabad, belonging to its wholly owned subsidiary, by offering a voluntary retirement scheme to nearly 26% of its workforce.

Once again, in FY2002, Godfrey Phillips India Ltd reduced its workforce further by letting go of more employees to reduce its operating costs and lead to savings.

FY2002 annual report, page 12:

Our efforts in rationalizing the workforce continued and we could reduce the number of people employed by as much as 84 including the managerial staff.

Thereafter, in FY2014, Godfrey Phillips India Ltd used the opportunity of the commencement of the new plant at Rabale, Navi Mumbai to reduce its costs when it gave VRS to all the staff at its older factory at Andheri.

FY2014 annual report, pages 28, 90:

Production at Cigarette plant at Andheri (Mumbai) was discontinued during the year under report.

The exceptional item represents compensation paid to unionized staff and workmen attached to the Company’s plant at Andheri, Mumbai, pursuant to the voluntary retirement schemes announced by the Company under the terms of settlement memorandum executed by it with the workers’ union.

In addition, the company has taken steps to close down its loss-making business units, which has also added to profitability.

In FY2020, Godfrey Phillips India Ltd changed its strategy related to the chewing tobacco business. It decided to stop focusing on the economical segment of the “Raag” brand and increased focus on the premium brand “Pan Vilas”.

FY2020 annual report, page 7:

While in FY’19 the chewing business was close to break even, this year business made some significant restructuring, made investments in Pan Vilas brand in premium segment and gradually pulled out itself from non performing mid premium segment.

In FY2021, due to continuing operating losses, the company did a thorough assessment of the chewing tobacco business.

FY2021 annual report, page 155:

In view of the continuing operating losses, the Group has reviewed the carrying value of its assets relating to chewing business and estimated the recoverable amount of assets

Thereafter, in Oct. 2022, it sold off the entire chewing tobacco business as it was continuing to make losses without any sight of profitability.

Corporate announcement to Bombay Stock Exchange (BSE), October 12, 2022:

This sale/assignment is in line with the Company’s decision to exit from its Chewing business which was incurring losses and constituted less than 2% of the total operating revenues

Similarly, in FY2018, Godfrey Phillips India Ltd closed down its tea division, which was making losses.

FY2018 annual report, page 7:

Tea has been an insignificant contributor to the Company’s business. During the course of 2017-18, it was decided to divest from this line of business

These steps of cutting down costs by relieving excess and expensive workforce as well as closing down loss-making business divisions have cut down costs for the company and over the years, have improved its profit margins.

The credit rating agency, CRISIL, acknowledged the role of cost-cutting measures taken by the company in the improvement of its profit margins.

Credit rating report, CRISIL, August 2022:

operating margin also improved to 23.7% owing to various cost-control measures adopted by GPIL

Therefore, we note that Godfrey Phillips India Ltd works in an industry, which has many regulatory constraints and the company cannot take free decisions to grow its business. This is because the high growth of cigarette/tobacco manufacturers means that the problem of smoking is becoming more severe in society.

Tobacco consumption puts a big burden on any economy in terms of healthcare costs, loss of manpower and productivity. As per World Health Organization (WHO), in 2018, India had to bear a cost of $27.5 billion due to tobacco consumption. (Source).

According to the World Health Organisation (WHO), the total economic costs from tobacco use from all diseases in India in 2018 was about $27.5 billion.

This is a humongous cost for a developing country. As a result, the Indian govt. does not support the tobacco industry in its quest for growth.

The govt. has stopped giving permissions for capacity expansion and banned foreign direct investment. It has put controls on the sale and consumption of tobacco products, disallowed advertising and marketing, put big pictorial warnings on packages and controlled tobacco cultivation. Govt. has put high taxes (excise duty, VAT etc.) to make tobacco products, especially cigarettes very expensive, which has limited the growth in the demand for cigarettes.

Cigarette manufacturers have requested the govt. for being lenient on them while putting taxes; however, the govt. has repeatedly increased taxes aggressively on tobacco products, especially cigarettes.

An investor should always keep these aspects of the business of Godfrey Phillips India Ltd while she tries to make any prediction about its future performance.

The tax payout ratio of Godfrey Phillips India Ltd has largely been in line with the standard corporate tax rate prevalent in India. Any small differences are primarily due to the differential tax rate of capital gains on the large amount of investments done by the company in equity and debt assets.

For example, in FY2021 and FY2022, the biggest factor leading to a difference in the standard tax rate and the tax payout ratio of Godfrey Phillips India Ltd was the “Differential tax rate on long-term capital gain on sale of investments”.

FY2022 annual report, page 168:

Operating Efficiency Analysis of Godfrey Phillips India Ltd:

a) Net fixed asset turnover (NFAT) of Godfrey Phillips India Ltd:

Over the years, the NFAT of the company has been stable in the range of 3.4 to 3.7. In recent years, the NFAT seems to have declined in the range of 2.5 to 2.7; however, the main reason for this decline is the change in accounting guidelines for leased assets.

From FY2020, the applicability of new Indian Accounting Standards (lease accounting) has led to the inclusion of leased assets (right-to-use assets) into fixed assets. Godfrey Phillips India Ltd has included leased assets/right-of-use assets of about ₹300-350 cr into its fixed assets from FY2020 onwards, which has led to a decline in the NFAT ratio calculations.

FY2020 annual report, page 144:

Therefore, the decline in the NFAT during FY2020-FY2022 is due to a change in accounting guidelines. If an investor removes the impact of the right to use/lease assets, then the NFAT of Godfrey Phillips India Ltd stays in the range of 3.6 during FY2021 and 3.8 in FY2022 indicating that the company has maintained the efficiency of usage of its fixed assets over the years.

Going ahead, an investor should keep a close watch on the NFAT of the company to assess whether it can use its fixed assets and manufacturing capacity optimally.

Further advised reading: Asset Turnover Ratio: A Complete Guide for Investors

b) Inventory turnover ratio (ITR) of Godfrey Phillips India Ltd:

In the past (FY2014-FY2022), the inventory turnover ratio (ITR) of the company has shown cyclical variations. During the initial years, the ITR of the company declined from 4.4 in FY2014 to 3.1 in FY2016. Thereafter, the inventory turnover ratio improved year on year and increased to 4.3 in FY2020. However, in the last two years, the inventory turnover ratio has declined to 3.4 in FY2022. One of the key reasons for the recent decline seems to be the covid-19 related supply chain problems.

Going ahead, an investor should keep a close watch on the ITR of the company to assess whether it is using its inventory efficiently.

Further advised reading: Inventory Turnover Ratio: A Complete Guide

c) Analysis of receivables days of Godfrey Phillips India Ltd:

Over the years, the receivables days of Godfrey Phillips India Ltd have stayed in a range of 10-20 days during FY2014-FY2022. A level of 10-20 days for receivables collection is good because, in most of the other industries, companies usually give a credit period of about 30-45 days to their customers.

Moreover, while reading the annual reports of Godfrey Phillips India Ltd, an investor notices that the share of its receivables more than 180 days overdue is considerably low.

For example, In FY2022, the company had about ₹3.5 cr of receivables overdue for more than 6 months out of total receivables of ₹157 cr i.e. about 2.3%. In FY2021, the company had about ₹7 cr of receivables overdue for more than 6 months out of total receivables of ₹129 cr i.e. about 5.5%.

FY2022 annual report, page 171:

Similarly, over the years, Godfrey Phillips India Ltd has had a very low percentage of receivables turning bad i.e. its customers had not paid for the goods purchased from it.

In FY2022, it wrote off ₹0.87 cr of receivables, which is 0.5% of the total receivables of ₹157 cr. In FY2021, it wrote off about ₹1 cr of receivables out of total receivables of ₹129 cr, which is 0.7%.

FY2022 annual report, page 181:

Therefore, it seems that Godfrey Phillips India Ltd has managed its receivables position well.

Going ahead, an investor should monitor the trend of receivables days of Godfrey Phillips India Ltd in both the standalone as well as consolidated financials to assess whether it is able to collect its receivables on time and keep its working capital position under control.

Further advised reading: Receivable Days: A Complete Guide

When an investor compares the cumulative net profit after tax (cPAT) and cumulative cash flow from operations (cCFO) of Godfrey Phillips India Ltd for FY2013-2022, then she notices that over the years (FY2013-FY2022), the company has converted its profit into cash flow from operations.

Over FY2013-22, Godfrey Phillips India Ltd reported a total net profit after tax (cPAT) of ₹2,455 cr. During the same period, it reported cumulative cash flow from operations (cCFO) of ₹3,156 cr.

It is advised that investors should read the article on CFO calculation, which would help them understand the situations in which companies tend to have the CFO lower than their PAT. In addition, the investors would also understand the situations when the companies would have their CFO higher than PAT.

Further advised reading: Understanding Cash Flow from Operations (CFO)

Learning from the article on CFO will indicate to an investor that the cCFO of Godfrey Phillips India Ltd is higher than the cPAT due to the following factors:

• Depreciation expense of ₹1,135 cr (a non-cash expense) over FY2013-FY2022, which is deducted while calculating PAT but is added back while calculating CFO.
• Interest expense of ₹186 cr (a non-operating expense) over FY2013-FY2022, which is deducted while calculating PAT but is added back while calculating CFO.

The Margin of Safety in the Business of Godfrey Phillips India Ltd:

a) Self-Sustainable Growth Rate (SSGR):

Read: Self Sustainable Growth Rate: a measure of Inherent Growth Potential of a Company

Upon reading the SSGR article, an investor would appreciate that if a company is growing at a rate equal to or less than the SSGR and it can convert its profits into cash flow from operations, then it would be able to fund its growth from its internal resources without the need of external sources of funds.

Conversely, if any company attempts to grow its sales at a rate higher than its SSGR, then its internal resources would not be sufficient to fund its growth aspirations. As a result, the company would have to rely on additional sources of funds like debt or equity dilution to meet the cash requirements to generate its target growth.

An investor may calculate the SSGR using the following formula:

SSGR = NFAT * NPM * (1-DPR) – Dep

Where,

• SSGR = Self Sustainable Growth Rate in %
• Dep = Depreciation rate as a % of net fixed assets
• NFAT = Net fixed asset turnover (Sales/average net fixed assets over the year)
• NPM = Net profit margin as % of sales
• DPR = Dividend paid as % of net profit after tax

(For systematic algebraic calculation of SSGR formula: Click Here)

Over the years, Godfrey Phillips India Ltd has reported an SSGR of about 15%, which is higher than the sales growth rate achieved by Godfrey Phillips India Ltd over the last 10 years (FY2013-FY2022). It indicates that the company could generate sufficient funds from its internal resources to fund its business growth.

Therefore, over the last 10 years (FY2013-FY2022), the company did not need to dilute its equity and also its debt level stayed stable at about ₹300 cr (in FY2013: ₹304 cr and in FY2022: ₹336 cr). Moreover, an investor may note that at the end of FY2022, the company had cash and investments of ₹1,894 cr indicating that it has a surplus net cash position.

An investor gets the same conclusion when she analyses the free cash flow position of Godfrey Phillips India Ltd.

b) Free Cash Flow (FCF) Analysis of Godfrey Phillips India Ltd:

While looking at the cash flow performance of Godfrey Phillips India Ltd, an investor notices that during FY2013-FY2022, it generated cash flow from operations of ₹3,156 cr. During the same period, it did a capital expenditure of about ₹1,104 cr.

Therefore, during this period (FY2013-FY2022), Godfrey Phillips India Ltd had a free cash flow (FCF) of ₹2,051 cr (=3,156 – 1,104).

In addition, during this period, the company had a non-operating income of ₹648 cr and an interest expense of ₹186 cr. As a result, the company had a net free cash flow of ₹2,513 cr (= 2,051 + 648 – 186). Please note that the capitalized interest is already factored in as a part of the capex deducted earlier.

While looking at the overall cash-flow position of Godfrey Phillips India Ltd over the last 10 years (FY2013-2022), an investor notices that the company has primarily used its free cash flow in the following manner:

• Payment of dividends to the shareholders: ₹686 cr excluding dividend distribution tax (DDT).
• An increase in cash & investments of about ₹1,584 cr i.e. from ₹310 cr in FY2013 to ₹1,894 cr in FY2022.

Going ahead, an investor should keep a close watch on the free cash flow generation by Godfrey Phillips India Ltd to understand whether the company continues to generate surplus cash from its business and keep its debt levels under control.

Further advised reading: Free Cash Flow: A Complete Guide to Understanding FCF

Self-Sustainable Growth Rate (SSGR) and free cash flow (FCF) are the main pillars of assessing the margin of safety in the business model of any company.

Further advised reading: 3 Simple Ways to Assess “Margin of Safety”: The Cornerstone of Stock Investing

Additional aspects of Godfrey Phillips India Ltd:

On analysing Godfrey Phillips India Ltd and after reading annual reports, credit rating reports and other public documents, an investor comes across certain other aspects of the company, which are important for any investor to know while making an investment decision.

1) Management Succession of Godfrey Phillips India Ltd:

Godfrey Phillips India Ltd is a part of the KK Modi group of companies. On September 30, 2022, KK Modi group, the Indian promoters, hold a 47.73% stake in the company whereas Philip Morris group holds a 25.1% stake. The KK Modi family control the day-to-day operations of the company.

The senior-most member of the family, Mr KK Modi died in Nov. 2019. He is survived by her wife, Ms Bina Modi, and three children: a daughter, Ms Charu Bharti and two sons, Mr Lalit Modi and Mr Samir Modi.

In the past, there has been a lot of turmoil in the succession of the KK Modi family’s business assets. During his lifetime, Mr KK Modi faced challenges in bringing all his children on the same page for succession planning. (Source: ‘I will sell my biz if kids can’t decide on successor’: Times of India, May 26, 2011)

Uncertainty over succession continues at the business empire of K K Modi, father of beleaguered Lalit Modi (the brain behind IPL). With no clear successor in sight among his three children, Modi senior has said he has made legal provisions to sell his over Rs 4,000-crore empire

K K Modi, who has tried to buy peace through a new organizational set-up, said the business would be on the block if the children do not agree on a leader

As a result, in 2011, he implemented an organizational setup by bringing in Mr Sarthak Behuria, ex-IOC chairman, and setting up three committees for the family businesses. (Source: KK Modi gets Behuria for professional consolidation: Business Standard, January 20, 2013)

The corporate management council (CMC), which will be the apex decision-making body will act as a forum to make strategic business decisions in consultation with other promoters.

At the group level, there will be a corporate executive committee (CEC) chaired by Behuria comprising senior directors, chief executive and operating officers

Bina Modi as chairperson of the family council will have a key role in aligning the long-term interests of family members.

However, after the death of Mr KK Modi, the differences between the successors came out in the open. When Ms Bina Modi, wife of Mr KK Modi was appointed President & Managing Director of the company, then Mr Ruchir Modi, son of Mr Lalit Modi, complained to SEBI challenging her appointment. (Source: Ruchir Modi flags corporate governance at Godfrey Phillips: Businessline, December 6, 2021)

Former IPL commissioner Lalit Modi’s son Ruchir Modi has yet again written to the market regulator SEBI…that his grandmother Bina Modi’s appointment as the company’s President and Managing Director (MD) is illegal.

Mr Ruchir Modi wrote to other authorities as well citing irregularities in the company’s operations, which led to the Central government’s inspection of the company’s accounts.

FY2021 annual report, page 23:

Mr. Ruchir Kumar Modi…has written various letters to the regulatory authorities such as the Securities and Exchange Board of India, The Ministry of Corporate Affairs and the Stock Exchanges, alleging certain irregularities by the Company and its officials, and seeking investigation into the affairs of the Company….Central Government has ordered inspection of the books of accounts and other books and papers of the Company

It seems that due to these actions, Mr Ruchir Modi was removed from the board of directors of the company by not reappointing him as a director when his initial term expired.

FY2021 annual report, pages 201, 217:

 “RESOLVED THAT the vacancy caused by the retirement by rotation of Mr. Ruchir Kumar Modi (DIN 07174133), be not filled by the Company for the time being.

NRC considered various aspects about Mr. Ruchir Kumar Modi such as the repeated concerns raised by the Board on his conduct in past being unbecoming of a director of the Company…including leveling unsubstantiated allegations against the Company and its officials

After the removal of Mr Ruchir Modi from the companies, there is no representation of Mr Lalit Modi or his children on the board of Godfrey Phillips India Ltd.

One news article in December 2021 claimed that the family dispute is nearing resolution and the family members have worked out monetary compensation to be provided to Mr Lalit Modi and his children. (Source: Godfrey Phillips promoters work out ₹11,000-crore settlement; Lalit Modi to get ₹917 crore: Businessline, December 6, 2021)

Lalit Modi, the former IPL Commissioner who is currently ensconced in London, will receive ₹917 crore initially as part of the settlement, the documents show. His son Ruchir Modi, who is at the helm at Godfrey Phillips, and daughter Aliya Modi, too, will receive ₹917 crore each as part of the settlement.

Currently, Ms Bina Modi (President, Managing Director & CEO, aged 77 years) and her youngest son, Mr Samir Modi (Executive Director, aged 52 years) are present on the board of the company.

An investor may contact the company directly to understand the current stage of progress in the succession planning of the KK Modi group and the plan for any leadership changes at the company.

Further advised reading: How to do Management Analysis of Companies?

2) Promoter’s remuneration at Godfrey Phillips India Ltd:

While analysing the remuneration taken by the promoter family members of the KK Modi group, an investor gets some key observations.

The following table has the data on remuneration taken by different members of promoters’ family from FY2009 to FY2022. The data is taken from the section “Remuneration to Directors” from the part “Report on Corporate Governance” from the annual reports of Godfrey Phillips India Ltd.

2.1) Promoters’ remuneration as a percentage of profit has increased significantly over the years:

The total remuneration of all the promoter family members used to be about 2% until FY2012. Thereafter, the promoters started increasing their remuneration and now, the total remuneration of the promoter’s family members has increased almost 3 times to about 6-7% of the net profit after tax.

If you notice that over FY2009 to FY2022, the net profit of Godfrey Phillips India Ltd has increased to 4 times, from ₹109 cr in FY2009 to ₹436 cr in FY2022. However, during this period, the remuneration of Mr Samir Modi has increased by more than 53 times i.e. from ₹0.5 cr in FY2009 to ₹26.8 cr in FY2022.

There have been periods when the financial performance of the company declined as reflected in the decline in the profit of the company over the previous year; however, even during those periods, the total remuneration taken by the promoters has increased.

For example, during FY2015-2017, the net profit of Godfrey Phillips India Ltd declined by 25% to ₹137 cr in FY2017 from ₹183 cr in FY2016. However, during this period, the total promoters’ remuneration increased by 70% to ₹14.4 cr in FY2017 from ₹8.5 cr in FY2015.

Similarly, during FY2013, the net profit of Godfrey Phillips India Ltd declined by 6% to ₹170 cr from ₹181 cr in FY2012. However, during FY2013, the total promoters’ remuneration increased by 33% to ₹5.8 cr from ₹4.4 cr in FY2012.

An investor will note that in FY2012, when Godfrey Phillips India Ltd had reported a net profit of ₹181 cr, then the promoters had taken a remuneration of ₹4.4 cr. However, in FY2017, when the company had a profit of ₹137 cr, then the promoter took home a much higher remuneration of ₹14.4 cr.

2.2) Increase in the remuneration of Mr Samir Modi in FY2018:

In 2017, Mr KK Modi decided that from FY2018 onwards, he would not take any cash remuneration from Godfrey Phillips India Ltd; he will only take company car, telephone and reimbursement of his travel expenses.

FY2017 annual report, page 206:

W.e.f 1st April 2017, Mr. Modi will not draw any salary and/ or commission from the Company nor shall he be entitled to any sitting fee during the remaining period of his current tenure.

In the previous year, FY2017, Mr KK Modi had taken home a total remuneration of ₹8.4 cr. Therefore, an investor may have thought that the money spent on Mr KK Modi’s remuneration may now become an increase in profit for Godfrey Phillips India Ltd.

However, in FY2018, while Mr KK Modi did not draw any remuneration, the remuneration of his son, Mr Samir Modi increased sharply by (116%) i.e. becoming more than double from ₹4.9 cr to ₹10.6 cr, an increase of ₹5.7 cr.

Effectively, most of the benefit to be accrued to Godfrey Phillips India Ltd by waiver of remuneration of one promoter member was given to another promoter member.

In family-run corporations, an investor will routinely come across such instances where when one member of the family stops drawing remuneration, then another family member gets into the picture to take a higher remuneration.

An investor may read another such example in the case of Sharda Motor Industries Ltd in the following article: Analysis: Sharda Motor Industries Ltd

In the case of Sharda Motor Industries Ltd, when the promoter of the company, Mr N. D. Relan expired in June 2016, then his wife, Ms Sharda Relan, aged 81 years, was appointed an executive director in August 2016 at a significant remuneration.

For the full year (FY2016), Mr N. D. Relan drew a remuneration of ₹3.06 cr whereas, in the first full year after his demise (FY2018), Ms Sharda Relan drew a remuneration of ₹4.64 cr.

Moreover, while going through the “Management Team” section of the website of the company, the investor notices that the name of Ms Sharda Relan does not appear in the list of key management personnel.

The case of an increase in the remuneration of Mr Samir Modi looks like a similar case where the promoter family does not want its total remuneration payout to reduce significantly when Mr KK Modi decided to forego his remuneration.

2.3) Remuneration of Mr Lalit Modi and his son, Mr Ruchir Modi:

From the FY1998 annual report, which is the earliest annual report available freely on the BSE website, an investor notes that Mr Lalit Modi and Mr Samir Modi, his younger brother, had been working as executive directors of the company and were drawing almost similar remunerations.

However, in the meanwhile, in FY2011, Godfrey Phillips India Ltd, changed the position of Mr Lalit Modi from an executive director to an ordinary (non-executive) director.

FY2011 annual report, page 18:

Mr. Lalit Kumar Modi…has ceased to be in the whole-time employment of the Company as an Executive Director w.e.f. 1st August, 2010 and thereafter continues as an Ordinary Director…Mr. Lalit Kumar Modi is entitled to payment of commission…at not more than one percent (1%) per annum of the net profits of the Company

An investor would remember that this was the period when Mr Lalit Modi was involved in the issues related to his role in the Indian Premier League (IPL) and around May 2010 he moved to London when the investigative agencies moved on him. (Source: Govt backs Sushma Swaraj in row over helping Lalit Modi: Livemint)

Modi, who fled to London in 2010, is wanted by India’s Enforcement Directorate on charges of financial irregularities.

This change in the type of directorship from an executive director to a non-executive director in August 2010 indicated that he was no longer involved in the day-to-day functioning of the company. Instead, Mr Lalit Modi would only attend the board meeting of the company, which are usually 4 to 8 during a year.

However, despite this major change in the work profile of Mr Lalit Modi at Godfrey Phillips India Ltd, he continued to draw a remuneration almost equal to his brother Mr Samir Modi, who continued to work as an executive director and was actively involved in the day-to-day functioning of the company.

In fact, in FY2012, Mr Lalit Modi earned a remuneration of ₹1.1 cr whereas he did not attend even a single board meeting out of the 5 board meetings conducted by Godfrey Phillips India Ltd in the year.

FY2012 annual report, page 16:

This looked like a case where a promoter who was not involved either in day-to-day active management or in any occasional board meeting; however, was taking home a significant remuneration. Usually, investors would expect such promoter family members to earn only dividends from the company for their shareholding.

Moreover, in the next year, the ceiling of the remuneration payable to Mr Lalit Modi was increased from earlier ₹1.1 cr to now ₹2.0 cr.

FY2013 annual report, page 1:

approval of the members be and is hereby accorded for payment of such sum to its non- executive director, Mr. Lalit Kumar Modi, by way of commission, not exceeding one percent (1%) per annum of the net profits of the Company…subject to a ceiling of Rs. 200 lacs per annum

Once again, in FY2014, Mr Lalit Modi did not attend any board meeting whereas he took home a remuneration of ₹1.7 cr.

FY2014 annual report, page 15:

Until FY2015, both the brothers, Mr Lalit Modi (a non-executive director) and Mr Samir Modi (an executive director) kept on drawing almost similar remunerations. In FY2015, both Mr Lalit Modi and Mr Samir Modi had taken home remuneration of ₹2 cr each.

Finally, in FY2016, from May 28, 2015, Mr Lalit Modi resigned from his position on the board of Godfrey Phillips India Ltd.

FY2015 annual report, page 11:

Mr. Lalit Kumar Modi vacated his office as the Director of the Company with effect from 28th May, 2015 by virtue of the provisions of Section 167 (1) (b) of the Companies Act, 2013.

However, in the same year, FY2016, his son Mr Ruchir Modi, aged 22 years, was appointed a non-executive director in Godfrey Phillips India Ltd with a remuneration of ₹1.50 cr.

FY2016 annual report, pages 44, 127, 128:

Mr. Ruchir Kumar Modi (DIN 07174133), who was appointed as an Additional Director (Non-Executive Director) of the Company with effect from March 19, 2016…payment of remuneration…a sum @ Rs. 1,50,00,000 (Rupees One crore fifty lacs) per annum, subject to a maximum of one percent (1%) of the net profit

Mr. Ruchir Kumar Modi is son of Mr. Lalit Kumar Modi, formerly Director of the Company.

Mr Ruchir Modi stayed on the board of Godfrey Phillips India Ltd until FY2021 and took home remuneration of about ₹1.50 each year until he was removed from the company due to his complaints to SEBI and other authorities against the appointment of his grandmother Ms Bina Modi.

An analysis of the remuneration drawn by Mr Lalit Modi and his son Mr Ruchir Modi from Godfrey Phillips India Ltd in a sequence looks like a case where Mr Lalit Modi wanted to take a remuneration of about ₹1 cr to ₹2 cr from the company despite not being involved in active management of the company.

When he left India in 2010 for London, then he changed his position at Godfrey Phillips India Ltd from an executive director to a non-executive director and continued to draw significant remuneration from the company. Later on, when he resigned from Godfrey Phillips India Ltd, then his son joined the company at the very young age of 22 years, as a non-executive director, and continued to earn remuneration of about ₹1.5 cr per year.

2.4) Remuneration of Mr Bina Modi:

In the case of Ms Bina Modi, an investor may notice that she is drawing very minimal remuneration of only a couple of lac rupees from Godfrey Phillips India Ltd. In fact, in FY2021 and FY2022, she has not drawn any remuneration from the company.

However, when an investor reads her terms of appointment to the board of Godfrey Phillips India Ltd, then she notices that her remuneration from the company is contingent on the amount of remuneration she draws from another KK Modi group company, Indofil Industries Ltd.

Dr. Bina Modi shall draw remuneration from the Company in addition to the remuneration drawn from Indofil Industries Limited, provided that the total remuneration drawn by her from both the companies shall not exceed the higher maximum limit admissible from any one of the two companies of which she is the managerial personnel.

The annual report of Indofil Industries Ltd for FY2022 shows that she took home a remuneration of ₹17 cr in FY2022 and about ₹14 cr in FY2021.

FY2022 annual report of Indofil Industries Ltd (click here), page 148:

This seems to be an arrangement of promoter family members where they do not want Ms Bina Modi to take home an excessive amount of money as remuneration from the group businesses. Therefore, she draws almost nil remuneration from Godfrey Phillips India Ltd because she draws remuneration of ₹17 cr from Indofil Industries Ltd.

In the above screenshot, an investor would notice that in FY2022, Ms Charu Modi, the daughter of the late Mr KK Modi has also drawn a remuneration of almost ₹17 cr from Indofil Industries Ltd.

In this light, when an investor observes that Mr Samir Modi, the youngest son of late Mr KK Modi has drawn a remuneration of ₹27 cr from Godfrey Phillips India Ltd, then she can assess that almost all the promoter family members are drawing substantial remunerations from one or other group companies.

An investor may do further analysis of KK Modi group companies to find out whether there is any group company from where the remaining child, Mr Lalit Modi is drawing significant remuneration or not. If not, then this might be one of the reasons for the discontent of Mr Lalit Modi/Mr Ruchir Modi, which is being expressed via complaints to regulatory authorities against the appointment of Ms Bina Modi as President and Managing Director of Godfrey Phillips India Ltd.

It is advised that an investor should always analyse the remuneration taken by promoter family members in detail to understand the patterns in the remunerations taken by individual family members as well as the entire family as a whole.

Advised reading: How to identify Promoters extracting Money via High Salaries

3) Dealings of Godfrey Phillips India Ltd with promoters about two land parcels:

In FY2008, Godfrey Phillips India Ltd decided to enter into the real estate business when one of its child entities, Rajputana Developers Projects, an association of persons (AOP), took over possession of two land parcels in Modinagar, UP for real estate development from one of its promoter-group-companies, Rajputana Fertilizers Limited.

FY2021 annual report, page 197:

A subsidiary of the Group, Rajputana Infrastructure Corporate Limited (RICL) had entered into an agreement with Rajputana Fertilizers Limited (RFL) dated 8th January, 2008, as amended, to give effect to their understanding and formed an Association of Persons (AOP) under the name and style of “Rajputana Developers Projects” (a former subsidiary) for carrying on the business activity of development of certain real estate vested in RFL…In terms of the said agreement, RFL had vested ownership, possession and title of two land parcels at Modinagar, jointly known as ‘Sikri Bagh Land’ in the AOP and RICL had committed to arrange the requisite financial resources to develop the said land parcels.

As per the FY2009 annual report, page 10, Rajputana Fertilizers Limited is one of the companies of the Modi group.

Persons constituting ‘Modi group’ coming within the definition of ‘group’ as defined in the Monopolies and Restrictive Trade and Practices Act, 1969…include the following:

• Rajputana Fertilizers Limited

It was a joint development project where the promoters brought in the land as their contribution, Godfrey Phillips India Ltd had to infuse the funds of construction, and both parties would share the profits.

Also read: How to do Business Analysis of Real Estate Companies

Accordingly, in FY2008, Godfrey Phillips India Ltd invested ₹23.2 cr in Rajputana Developers Projects (the association of persons, AOP) as interest-free loans.

FY2015 annual report, page 90:

as on Balance Sheet date, there is an outstanding interest free unsecured demand loan amounting to Rs. 2320 lacs, granted by a subsidiary company to its wholly owned subsidiary which was given during financial year 2007-08.

FY202015 annual report, page 120:

However, the land parcels contributed by the promoters had some disputes. Because of ongoing litigations, the real estate developments of these land parcels could not take place.

FY2021 annual report, page 197:

However, due to continuing litigation in respect of these land parcels and not so conducive real estate market conditions, not much progress could be made towards developing them for commercial gains.

It looked like a situation where the promoters did not bring in clear, developable land. As a result, shareholders of Godfrey Phillips India Ltd were suffering for no fault of theirs because they had already given invested a substantial amount of money (₹23.2 cr), which was not even earning any interest.

Now, in its commercial judgment, Godfrey Phillips India Ltd, instead of asking its money back with some penalty/interest, decided to give an exit to the promoters by buying out its share in the AOP (Rajputana Developers Projects), which was controlling the land.

Therefore, Godfrey Phillips India Ltd slowly started buying out the promoters from the AOP by gradually increasing its stake in the AOP.

FY2017 annual report, page 112:

Godfrey Phillips India Ltd used to have a stake of 40.94% in the AOP in FY2015, which increased to 49.90% by FY2017.

By FY2020, Godfrey Phillips India Ltd had increased its stake in the AOP to 63.79% (FY2020 annual report, page 26).

Moreover, Godfrey Phillips India Ltd intimated to its shareholders that it intends to buy out the promoters by paying ₹20 cr to the promoters by increasing its stake in the AOP to 95% by FY2025.

FY2020 annual report, page 178:

Includes Rs 2000.00 lakhs which the Group has contracted to pay to the other members of the AOP in order to increase its own share in the AOP to 95% by March 31, 2025

Investors may note that by increasing its stake in the AOP, Godfrey Phillips India Ltd was effectively buying out the disputed land from the promoters, which could not be developed in the last 12 years.

Further, Godfrey Phillips India Ltd did not wait until FY2025 to buy out 95% of the land parcel. In FY2021 itself, it completely bought out these disputed land parcels from the promoters.

FY2021 annual report, page 198:

Subsequently, two subsidiaries of the Group, namely Rajputana Infrastructure Corporate Limited (RICL) and Friendly Reality Projects Limited (FRPL) purchased title, rights, and interest in these land parcels from Rajputana Fertilizers Limited (RFL)…despite there being some long pending litigations.

Now, an investor may have her own interpretations about this whole transaction. Some may consider it as a long-term investment by Godfrey Phillips India Ltd into two disputed land parcels, which may get an increase in price in the future. Others may see it as a situation where the promoters have sold off two disputed and undevelopable land parcels to Godfrey Phillips India Ltd.

An investor may choose her pick.

Advised reading: How Promoters benefit from Related Party Transactions

4) Godfrey Phillips India Ltd paid money to promoter entities for their excise duty liabilities:

In FY2000, the company started outsourcing cigarettes from some companies in Assam. The company was happy that it has found a source of cigarettes, which is cheaper than its own manufacturing units.

FY2000 annual report, page 12:

Company has, in the last few months, entered into arrangements with small scale manufacturing units in Assam for purchase of cigarettes under Company’s brands. These arrangements are beneficial to the Company, since the prices at which these products are procured are lower.

The next year, in FY2001, the company was very happy that despite increasing taxes by the Govt., it was able to maintain its cigarette prices because it was sourcing cigarettes at a cheaper price from Assam units.

FY2001 annual report, page 13:

The Company was able to maintain the price of many of its cigarette brands on account of the fact that a part of its requirement was being sourced at a lower cost from manufacturing units in Assam.

However, at the same time, Godfrey Phillips India Ltd disclosed that now these units have stopped business and its ₹27.7 cr is stuck with these entities because they are not able to refund the advance money given by it to them.

FY2001 annual report, page

Thereafter these units have closed down their operations. However, there is a net outstanding amount of Rs.27.7 crores as on date, recoverable from these units against the amount of advances given to them by the Company

Godfrey Phillips India Ltd intimated to its investors that these units were to get a refund of deposits from excise authorities, which the govt. has now refused. Therefore, they are not able to repay Godfrey Phillips India Ltd.

Later on, the govt. retrospectively amended the laws to prevent demands of such refunds and the Hon. Supreme Court upheld this amendment. Therefore, these entities lost the right to these refunds and instead had to pay even the previous excise duty refunds that they had taken from the Govt.

FY2006 annual report, page 4:

The Supreme Court of India upheld the retrospective levy of excise duty that adversely affected certain cigarette manufacturers who had set up manufacturing facilities in Assam and supplied cigarettes to your company.

Now, instead of trying to recover its ₹27.7 cr from these entities, Godfrey Phillips India Ltd revised the price at which it had bought cigarettes from these entities so that they can pay the demands made by the govt.

FY2006 annual report, page 4:

Your company had to conclude a settlement with the Assam cigarette supplier companies agreeing to revise the price in respect of cigarettes supplied by the two Assam supplier companies.

Due to this decision of Godfrey Phillips India Ltd, instead of recovering its dues of ₹27.7 cr, shareholders of Godfrey Phillips India Ltd had to pay about ₹62 cr to these Assam-based companies, which now turned out to be promoter-owned-entities.

FY2006 annual report, page 59:

Disclosure of transactions between the Group and related parties:

Current year figure includes sums of Rs. 2489.76 lacs relating to Assam Cigarettes Company Pvt. Ltd. and Rs. 3682.02 lacs to R C Tobacco Pvt. Ltd. towards additional consideration for cigarettes purchased in an earlier year.

Therefore, instead of getting ₹27.7 cr from promoter-owned-entities, Godfrey Phillips India Ltd ended up paying them ₹62 cr. It was effectively, a net loss of about ₹90 cr (= 27.7 + 62) for the shareholders of Godfrey Phillips India Ltd.

Advised reading: Why Management Assessment is the Most Critical Factor in Stock Investing?

5) Capital allocation decisions of Godfrey Phillips India Ltd:

As the govt. regulations do not support unrestricted growth in the tobacco industry; therefore, over the years, Godfrey Phillips India Ltd has attempted to bring diversification to its business. The company has attempted to venture into non-tobacco products as well as other tobacco products other than cigarettes.

Over the last few decades, Godfrey Phillips India Ltd has ventured into the following areas:

• Tea
• Confectionary
• Retail (24*7 stores)
• Chewing tobacco products
• Real Estate

However, an assessment of its diversification attempts analysed by the performance of major “non-tobacco” segments from the section “Segment Information” in its annual reports indicates that Godfrey Phillips India Ltd has failed to generate any profit from its diversification ever.

In the last 20 years, since FY2002 when Godfrey Phillips India Ltd started disclosing its segment performance between the tobacco and non-tobacco segments, it has always lost money in the non-tobacco segments like tea, retail and other segments.

During FY2002-FY2022, Godfrey Phillips India Ltd lost about ₹659 cr.

5.1) Tea:

Godfrey Phillips India Ltd diversified into the Tea segment in FY1998.

FY1998 annual report, page 8:

humble beginning on diversifying our business to blending and marketing of our own Teas under the name of Tea City.

However, the company faced challenges immediately upon diversifying into tea as the govt. imposed excise duty on packet tea. As a result, the company faced strong competition from loose tea, which was not covered under the excise duty.

FY1998 annual report, page 13:

With the imposition of Excise Duty on Packet Tea in this financial year in the Union Budget 1998-99, packet tea segment can expect strong competition from the loose tea market which has been left untouched by Excise.

Soon, the tea segment faced an oversupply situation and strong competition from local unbranded players. Moreover, the overall market started declining.

FY2002 annual report, page 12:

domestic tea market faced difficult trading conditions due to bearish sentiment in commodity prices, over supply conditions and aggressive inroads made by local players. The overall market declined by over 6 %.

As per the company, the tea market continued to decline in subsequent years leading to strong competition from local players.

FY2004 annual report, page 17:

Retail audit data pointed to an 8% decline in the domestic branded packet tea market with further fragmentation due to a plethora of local players.

Godfrey Phillips India Ltd attempted to salvage the tea business by merging its distribution channel with the cigarette distribution channel.

FY2006 annual report, page 3:

With the process of integration of tea distribution with cigarettes distribution, your Directors are confident of higher turnover of tea in the years ahead.

However, the condition of the tea business did not improve. Moreover, in FY2010, the tea business faced further challenges when one of its key export markets, Kazakhstan, increased import duty on tea making imports unviable.

FY2010 annual report, page 5:

Tea exports, however, registered negative growth mainly on account of loss of business in Kazakhstan due to their Government raising import duty on packet tea rendering the imports unviable.

Subsequently, in FY2015, tea exports suffered when excess tea production in Kenya brought down prices.

FY2015 annual report, page 8:

Tea exports suffered a de-growth of sixteen per cent, owing to the sharp fall in prices of competing Kenyan teas.

Oversupply from Kenyan tea at low prices continued even until FY2017 and put a big pressure on Godfrey Phillips India Ltd.

FY2017 annual report, page 8:

bulk tea exports business faced a challenging year due to unfavorable global market conditions such as sharp drop in Kenyan CTC prices

After facing all these challenges in the tea business and suffering losses continuously for nearly 20 years, finally, Godfrey Phillips India Ltd decided to close the tea business in FY2018.

FY2018 annual report, page 7:

Tea has been an insignificant contributor to the Company’s business. During the course of 2017-18, it was decided to divest from this line of business

5.2) Chewing tobacco products:

When govt. of India was aggressively increasing excise duty on cigarettes continuously, then it created a demand shift from consumers to chewable tobacco products, which had a low excise duty burden. To capture this demand, Godfrey Phillips India Ltd entered into the chewable tobacco business by launching Pan Vilas in FY2010.

The Company aggressively grew this segment by covering more states and launching new products in this segment like Raag pan masala for the price-sensitive customer. In FY2013, the company also launched products in the zarda segment with brands Swarn Vilas and Tarana.

FY2013 annual report, page 8:

While ‘Pan Vilas’ continues to be the flagship offering, an economy pan masala variant under the brand ‘Raag’ is in the process of being launched in the markets like: UP, MP, Jharkhand, Orissa, and Gujarat…We are operating in zarda segment with the brands ‘Swarn Vilas’ and ‘Tarana’.

However, within a few years, by FY2015, Godfrey Phillips India Ltd realized that the chewable tobacco business is also tough and is not performing as per expectations.

FY2015 annual report, page 8:

Your Company suffered a setback in its foray into chewing business during the year despite investing significant time and money to develop the business.

By FY2019, the company realized that despite the best of its efforts in sales, advertising and marketing, the chewable tobacco business is not making profits. Therefore, out of the two segments, it decided to focus only on the premium segment with the brand “Pan Vilas” and close down the economy segment brand “Raag”.

FY2019 annual report, page 3:

Chewing products sales declined 25% as company focused on premium Pan Vilas instead of economy Raag. This trend will continue in coming years.

In FY2020, Godfrey Phillips India Ltd told its investors that it is committed to making the chewable tobacco segment profitable and therefore, it is only focusing on the premium segment “Pan Vilas”.

FY2020 annual report, page 7:

this year business made some significant restructuring, made investments in Pan Vilas brand in premium segment and gradually pulled out itself from non performing mid premium segment…Going forward, single minded objective is to make the business profitable by focusing in premium segment

In FY2021, the group reassessed the business as it was continuously making losses.

FY2021 annual report, page 155:

In view of the continuing operating losses, the Group has reviewed the carrying value of its assets relating to chewing business and estimated the recoverable amount of assets

Finally, in Oct. 2022, after about 12 years of entering the chewing tobacco business, Godfrey Phillips India Ltd realized that it is not able to run this business profitably. Therefore, it sold off the business.

Corporate announcement to Bombay Stock Exchange (BSE), October 12, 2022:

This sale/assignment is in line with the Company’s decision to exit from its Chewing business which was incurring losses and constituted less than 2% of the total operating revenues

5.3) Retail business Twenty-Four Seven (24*7):

In FY2010, Godfrey Phillips India Ltd entered into the retail business to diversify its business into non-tobacco segments.

FY2010 annual report, page 2:

Godfrey Phillips India diversified into retail segment with the launch of Twenty Four Seven Stores.

The company decided to expand the business soon and entered into a tie-up with Indian Oil Corporation to open stores at its 100 fuel outlets.

FY2011 annual report, page 6:

Twenty Four Seven has also successfully tied up with Indian Oil Company, for 100 stores across Northern India. The first test pilot retail outlet was launched in February 2010 at the prime location, Delhi Golf Club.

In FY2013, the company realized that the retail business is not making profits and it engaged consultants from Japan to evolve its business model and grow further.

FY2013 annual report, page 8:

35 stores spread across NCR and expects to more than double this number during the current year. New business models are currently under evaluation with the help of Japanese consultants

By FY2019, the company had grown its retail business to more than 100 stores.

FY2019 annual report, page 8:

The 24Seven chain of convenience stores had shown a rapid growth during FY 19 and opened 43 new stores…number of stores increased from 61 to 104

However, despite the growing number of retail stores, the business was not making profits. Therefore, in FY2020, Godfrey Phillips India Ltd decided that instead of increasing the number of stores, it should focus on making its existing stores profitable.

FY2020 annual report, page 2:

As a part of our core strategy, we are focused on enhancing operational efficiency at store level and therefore limiting ourselves from adding new stores. The total number of stores count was 103 at the end of March 2020.

In FY2021, the company closed down about 10 stores and it reported 93 stores in comparison to 103 stores in FY2020.

FY2021 annual report, page 3:

Godfrey Phillips operates the 24Seven convenience store chain with 93 stores in northern part of India.

In FY2022, the company again added more stores to have 105 stores. However, an investor may note from the table shared earlier that the retail business of Godfrey Phillips India Ltd has never made profits ever since its start in FY2010.

Moreover, in FY2021, Godfrey Phillips India Ltd reassessed its investments in the retail business in light of continued losses.

FY2021 annual report, page 155:

In view of the continuing operating losses, the Group has reviewed the carrying value of its assets relating to retail business and estimated the recoverable amount of the assets.

Apart from these segments, Godfrey Phillips India Ltd also attempted to enter into the confectionaries and real estate business; however, none of these businesses could bring any profits to the shareholders of Godfrey Phillips India Ltd.

Over the years, there have been instances where Godfrey Phillips India Ltd has written off entire investments done by it in different companies and subsidiaries. For example, in FY2019, it wrote off its entire investment in the subsidiary Flavors & More Inc. and suffered a loss of about ₹15 cr.

FY2019 annual report, page 69:

The Company identified impairment in carrying value of investment in one of its subsidiary ‘Flavors & More Inc.’ owing to its decision for closure of business operations of the said subsidiary. Impairment charge of Rs. 1,508.50 lakhs has been recorded in the current year.

In addition, there have been instances when Godfrey Phillips India Ltd decided to sell some assets; however, it could not sell them for a couple of years and during which time the assets lost their entire remaining value and had to be written off to almost entire loss.

At the start of FY2016, Godfrey Phillips India Ltd had identified assets of about ₹9 cr to be sold. However, out of these, over the next three years i.e. FY2016, FY2017 and FY2018, the company could sell assets of only ₹1.15 lac. Therefore, almost all the assets of about ₹9 cr were written off by the end of FY2018.

FY2017 annual report, page 161:

FY2018 annual report, page 155:

It might be a case where taking prompt actions by the company to sell these assets might have salvaged some value and would have prevented the loss to the shareholders.

Advised reading: How to Identify if Management is Misallocating Capital

6) Raids on Godfrey Phillips India Ltd by tax authorities:

The company has multiple times had raids on its premises by different tax authorities. In a recent instance, income tax authorities search its offices. Dept. officials took away some records of the company.

FY2021 annual report, page 127:

The Income Tax Department had searched the office premises of the Company in February 2021 in connection with search carried out by them under Section 132 of the Income Tax act, 1961 on a promoter of the Company. The tax officials have taken custody of certain records of the Company and recorded statements of some of the Company officials.

In the past also, the company had been subjected to search & seizure operations by Income Tax authorities. After one such operation, the govt. authorities had put up a demand of ₹56 cr on the company for which it settled for a payment of about ₹25 cr in FY1999 under “Kar Vivad Samadhan Scheme, 1998”

FY1999 annual report, page 12:

Company availed of the benefit of “Kar Vivad Samadhan Scheme, 1998” with a view to voluntarily settle the disputed excise demands aggregating to Rs. 56 crores on the Company…the necessary adjustments for the amounts paid have been made in the books, and a sum of Rs. 2516.89 lacs (net of tax) has been charged to the profit and loss account

In FY2022, under contingent liabilities, Godfrey Phillips India Ltd has disclosed tax demands of about ₹84 cr, which it has not accepted (FY2022 annual report, page 182). Apart from it, demands of about ₹160 cr are under dispute and litigation is still going on at different forums (FY2022 annual report, pages 65-66). Out of these, for demands of about ₹142 cr, the company has received decisions in its favour; however, the govt. authorities have challenged it in courts or higher forums.

An investor should note that if the company has received a decision in its favour in one forum, then it cannot rest assured that it will not have to pay the tax demand. There have been cases where in the courts or higher forums, the tax authorities have won the appeal. For example, in FY2020, the tax authorities won a case against the company in the High Court.

FY2020 annual report, page 185:

Out of this Rs.1366.56 lakhs relates to an order received during the current year from the Allahabad High Court upturning the earlier order of the CESTAT in favour of the subsidiary company.

Therefore, always while assessing the amount of tax demands, an investor should keep in her mind that decisions can go against the company as well and it may be a significant hit to the financial position of any company.

7) Accounting and governance by Godfrey Phillips India Ltd:

In the past, there have been occasions when the company has not followed the established accounting norms and the auditors and tax authorities have pointed it out.

For example, previously, while determining the value of unsold finished goods in the inventory, Godfrey Phillips India Ltd did not include the excise duty applicable to them. As a result, the value of inventory would be lower on the balance sheet. This would reduce a lower amount from the cost of goods sold in the profit & loss account (P&L) and effectively, would increase expenses in P&L and reduce profits leading to a lower tax outgo.

The auditor of Godfrey Phillips India Ltd had pointed it out in its annual reports. For example in FY1998, the auditor pointed out that the company’s method of valuing finished goods inventory is not in line with the official guidelines and the company has shown such an inventory at a lower value by about ₹36 cr.

FY1998 annual report, page 15

in accordance with the accounting policy consistently followed by the Company, excise duty is not considered as an element of cost for valuation of finished goods inventory (Refer Note 7). The amount of excise duty relating to the closing stock of finished goods as at March 31, 1998 and not considered for valuation is Rs. 3579.90 lacs. Had the Company followed the method of including excise duty for valuation of finished goods as at March 31, 1998 as recommended in the guidance note…the profit after tax for the year would have been higher

However, in response, Godfrey Phillips India Ltd simply stated that it does not agree with the views of the official authorities and therefore, it has not included excise duty in the finished goods inventory.

FY1998 annual report, page 31:

Research Committee has revised its earlier opinion and suggested that excise duty should form part of the inventory valuation. The Company does not agree with the views so expressed by the Research Committee and therefore, the same have not been given effect to while valuing the finished goods inventory.

However, even the Income Tax dept. did not appreciate the company’s refusal to follow the official guidelines and raised tax demands against the company.

Therefore, finally, Godfrey Phillips India Ltd decided to reverse its stance and follow the official accounting guidelines and paid an additional tax of about ₹12 cr using the ‘Kar Vivad Samadhan Scheme, 1998’.

FY1999 annual report, pages 12, 32:

Since the tax department did not accept the basis of valuation…the Company considered it prudent to provide for the consequential and disputed liability…Company also sought to avail…‘Kar Vivad Samadhan Scheme, 1998‘…resolved the matter for the assessment years 1984-85 to 1991-92 for Rs.879.65 lacs. For other assessment years…provision of Rs.306.30 lacs has been made in the accounts.

the Company has decided to change its method of valuation to be in line with the Income-tax provisions.

In the next year, FY2000, Godfrey Phillips India Ltd had to make another change in its accounting policies related to the valuation of finished goods. Previously, the company did not include the value of production overheads related to the production of cigarettes in its valuation of unsold cigarettes (finished goods). A lower valuation of unsold cigarettes had an impact of reducing profits and tax payout, as explained earlier.

Therefore, in FY2000, the company had to again update its valuation method of unsold cigarettes (finished goods) to include production overheads.

FY200 annual report, page 31:

the Company has changed its method of valuation from direct costing to absorption costing by including appropriate share of production overheads in their valuation.

Due to this change in accounting policy, Godfrey Phillips India Ltd had to make provisions for payments to tax authorities.

Among all these instances of accounting changes, in the next year, FY2001, Godfrey Phillips India Ltd suffered from a fire in its office in which all its accounting records from its inception in 1981 were destroyed.

FY2001 annual report, page 30:

A fire took place at the 3rd floor of the Corporate Office of the Company…As a result, almost all the books of account, supporting vouchers and other accounting records maintained at this office since its inception in 1981…were destroyed.

Due to the destruction of records, the quality of the audit work suffered as the auditor no longer could see the original records for doing the audit. For example, the auditor pointed out that it could not confirm whether the personal expenses of directors/employees are charged to the company.

FY2001 annual report, page 17:

According to the information and explanations given to us, no personal expenses of employees or directors have been charged to revenue account…However, we are unable to comment on the expenses, if any, incurred at corporate office during the period April 1, 2000 to December 5, 2000 as the original supportings have been destroyed in fire.

At times, Godfrey Phillips India Ltd has faced instances of fraud by employees, which indicates that the internal controls and processes at the company leave room for improvement. For example, in FY2009 and FY2011, certain employees did fraud against the company.

FY2009 annual report, page 27:

no fraud on or by the Company has been noticed or reported during the year ended March 31, 2009, other than defalcation by employees of Rs. 0.30 lacs.

FY2011 annual report, page 29:

no fraud on the Company has been noticed or reported during the year, other than defalcation of Rs. 2.47 lacs by an employee

Apart from the above, the auditor also pointed out instances when the company did not follow the applicable guidelines of corporate governance; for example, in FY2015, the company conducted meetings of the audit committee even when the required number of independent directors were not present in the meetings.

FY2015 annual report, page 31:

One out of two Independent Directors were not present at the audit committee meetings held on 28th May, 2014 and 09th November, 2014.

At times, the information provided by the company in the annual reports seems insufficient, for which an investor may need to contact the company directly for further clarifications.

One such instance is the consolidation of profits of IPM India Wholesale Trading Pvt. Limited (IPM), an associate of the company (24.8% shareholding), which it had formed with Philip Morris group for the marketing of Marlboro cigarettes.

FY2022 annual report, page 197:

@relates to transactions with IPM India Wholesale Trading Private Limited…on account of sale/ purchase of Marlboro cigarettes manufactured by the Company.

In 2021, IPM reported a net profit of about ₹275 cr. As per the 24.8% shareholding of the company in IPM, its share of profit would be about ₹68 cr, which is a substantial amount. However, none of it was included in the financial reporting of Godfrey Phillips India Ltd.

FY2022 annual report, page 16:

The reason given by the company for the non-inclusion of its share of profits of IPM in the consolidated financials is that the losses incurred by IPM are more than the investment of ₹4.96 cr made by the company in IPM.

Upon analysis of profits earned by IPM since FY2015, from the time, Godfrey Phillips India Ltd started reporting the data of profit of IPM in its annual report, an investor gets to know that IPM has earned a total profit (after factoring in losses in FY2015-FY2017) of ₹440 cr.

Now, an investor is not able to assess why despite making a profit of more than ₹700 cr from FY2018 to FY2022, still IPM is not able to overcome the losses incurred in the previous years. This question will stay unanswered forever until Godfrey Phillips India Ltd discloses the amount of losses that IPM had made, which need to be recovered before it can start consolidating its share of profit from IPM in its consolidated financials.

Until the share of profits from IPM is consolidated in the financials of Godfrey Phillips India Ltd, the shareholders are not able to assess the benefit that the company is earning by making and distributing Marlboro, the largest-selling cigarette brand in the world.

An investor may contact Godfrey Phillips India Ltd directly to seek any more clarifications in this regard.

In FY2009, the company disclosed that it has received a notice of termination of the lease of a land parcel from the Govt. of UP, for which the company has filed a case in the High Court.

FY2009 annual report, page 59:

in respect of land for which a notice for termination of lease has been received from Government of U.P., which notice has been disputed by the Group in a petition filed before the Allahabad High Court

The same dispute has continued until now as the company has made such disclosure in the FY2022 annual report on page 183 as well.

From the limited information shared by the company, an investor is not able to know which this land parcel is. Is it the land on which one of the key cigarette manufacturing plants of the company is situated in UP? If this is the case, then any adverse decision from the court may have a significant impact on the operations of the company.

An investor may contact the company directly for further clarifications related to this land parcel.

Other than the above, there are certain small instances, which also indicate that internal controls including the process of maker-checker leave scope for improvement at Godfrey Phillips India Ltd.

For example, in the AGM notices of 2018 and 2021, while presenting the details of Mr Samir Modi under the directors seeking reappointment, in 2021 the company simply copied and pasted details from 2018. As a result, the age of Mr Samir Modi in both the FY2018 annual report, page 209 and the FY2021 annual report, page 215 is published as 48 years.

Similarly, on the website of Godfrey Phillips India Ltd, in the section “ABOUT US > THE LEAF DIVISION” (click here), the same paragraph is repeated twice.

An efficient system of maker-checker and good process controls would have avoided such errors.

In light of instances of all the above instances, an investor should always apply a high level of due diligence while analysing the company.

Advised reading: 7 Signs to tell whether a Company is cooking its Books: “Financial Shenanigans”

The Margin of Safety in the market price of Godfrey Phillips India Ltd:

Currently (December 19, 2022), Godfrey Phillips India Ltd is available at a price-to-earnings (PE) ratio of about 17.4 based on consolidated earnings of the last 12 months ending September 2022 (Oct. 2021 – Sept. 2022).

However, we recommend that an investor may read the following articles to assess the PE ratio to be paid for any stock, which takes into account the strength of the business model of the company as well. The strength in the business model of any company is measured by way of its self-sustainable growth rate and the free cash flow generating the ability of the company.

In the absence of any strength in the business model of the company, even a low PE ratio of the company’s stock may be a sign of a value trap where instead of being a bargain; the low valuation of the stock price may represent the poor business dynamics of the company.

• 3 Principles to Decide the Ideal P/E Ratio of a Stock for Value Investors
• How to Earn High Returns at Low Risk – Invest in Low P/E Stocks
• Hidden Risk of Investing in High P/E Stocks

Analysis Summary

Overall, Godfrey Phillips India Ltd seems a company, which has grown its sales at a moderate pace of 3% year on year for the last 10 years (FY2013-FY2022). The pace of growth has been slow because the govt. wants to restrict the spread of smoking in society and to achieve this objective; it creates many limitations for the growth of cigarette and tobacco manufacturing companies.

The govt. has banned the sale of tobacco to customers below 18 years of age and sale within 100m of educational institutes. Govt. has banned smoking in public places. It has banned advertising by tobacco companies in the mainstream media as well as at the point of sale in retail shops. Cigarette-making companies have to show pictorial warnings of health damages caused by tobacco consumption, a picture of oral cancer on 85% area on both sides of the packets.

Govt. has put cigarette manufacturing under compulsory license and has stopped giving approvals for any manufacturing capacity expansions. Govt. has also banned foreign direct investment (FDI) in the cigarette-manufacturing sector to limit its access to capital. In addition, govt. does not promote tobacco cultivation in the country.

In addition to these regulatory controls, govt. has put high taxes on tobacco products especially cigarettes to make them expensive and out of reach for most of the population. An increase in taxes has restricted the growth rates of tobacco consumption and the entire industry has grown at a rate of about 1% year on year for the last 40 years.

The increasing tax burden has affected Godfrey Phillips India Ltd significantly because the customers shift to cheaper alternatives like bidi, and gutkha, which are lightly taxed. The company is not able to increase prices at its will because of intense competition from the market leader, ITC Ltd, and illegally smuggled cigarettes. This has put pressure on the profitability of Godfrey Phillips India Ltd.

Nevertheless, the company has worked hard to reduce its costs and bring in more efficiencies in its operations. As a result, Godfrey Phillips India Ltd has improved its profit margins over the last 10 years. The company has managed its working capital well and has generated a lot of free cash flow from its operations. Therefore, it has a lot of surplus cash.

Godfrey Phillips India Ltd has attempted to diversify into many other segments like tea, retail, confectionary, real estate, chewing tobacco etc. However, none of these steps resulted in profitable growth for the shareholders. Godfrey Phillips India Ltd has lost money in all these initiatives and over the years, it closed down tea and chewing tobacco businesses.

The promoters of Godfrey Phillips India Ltd, the KK Modi family, are undergoing a lot of struggle related to succession planning. The attempts by the late Mr KK Modi to bring in a smooth succession by way of family organization failed and after his death, the succession struggle erupted. Now, as per some media articles, the family plans to solve this by distributing cash to family members. Nevertheless, an investor needs to contact the company to understand the exact status of succession planning.

Over the years, Godfrey Phillips India Ltd has given increasingly high remunerations to promoter family members where some of the members have got substantial remuneration without seemingly proportionate contributions to the company. In one instance, it appears that Godfrey Phillips India Ltd has bought out a troubled land parcel from its promoters, which it could not develop in the last 12 years.

Once, Godfrey Phillips India Ltd purchased cigarettes from promoter-owned entities and when the govt. withdrew the excise benefits from the promoter entities, then it revised the payment terms and paid a substantial amount to promoter entities for cigarettes purchased in the past so that they could pay the excise duty demands to the govt.

Godfrey Phillips India Ltd has been involved in tax-related disputes with authorities many times in the past. There have been multiple instances of IT raids on the company and at times, it has taken benefits of tax amnesty schemes to resolve tax disputes.

There have been many occasions when the company did not comply with the required accounting and governance norms. The auditors of the company pointed out these discrepancies and the tax authorities raised disputes. Later on, the company had to comply with the correct accounting principles.

On many occasions, the information provided by Godfrey Phillips India Ltd in the annual report proved insufficient for proper conclusions. As a result, an investor needs to do in-depth due diligence while analysing the company.

Going ahead, an investor should closely monitor regulatory developments related to the tobacco sector especially cigarettes because there are consistent demands from anti-smoking activists about increasing the tax rates, the minimum age of smoking and the closure of smoking zones at public places. She should focus on the transactions of the company with the promoter’s family members and their companies because such transactions can be a way to transfer economic benefits from public shareholders to the promoters.

An investor should analyse all the diversification decisions as well as the performance of the retail division to assess whether these diversification steps are able to generate a profit for the company ever. She should read the accounting policies and the auditor’s comments carefully to know if there are any deviations from the accepted accounting norms.

Further advised reading: How to Monitor Stocks in your Portfolio

These are our views on Godfrey Phillips India Ltd. However, investors should do their own analysis before making any investment-related decisions about the company.

You may use the following steps to analyse the company: “Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks”

I hope it helps!

Regards,

Dr Vijay Malik

P.S.

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Disclaimer

Registration status with SEBI:

I am registered with SEBI as a research analyst.

Details of financial interest in the Subject Company:

I do not own stocks of the companies mentioned above in my portfolio at the date of writing this article.