While strong distribution may help capture market share from illegal segment, price differential may cap gains
Every time the duty on cigarettes is raised, ITC’s margin profile improves. It’s not surprising, then, that after the rise in excise duty (on cigarettes) in this year’s Budget, ITC’s stock has risen 11 per cent. The market expects it to increase its margins this time, too, as it had done in the past few years. To offset the excise duty increase of 20 per cent, the company has increased prices by a weighted average of 12 per cent.
While the market broadly expects margins to improve, it is divided on volume growth expectations. Most analysts believe despite the rise in prices, demand will be hurt as cigarettes are a matter of habit. Espirito Santo believes that following the rise in prices, the company may see year-on-year volumes decline at an estimated five per cent in FY13. This is in contrast to the market’s expectation of a flat to marginal decline in volumes. This perception is driven by the performance of competitors like VST Industries and Godfrey Phillips, which are seeing better volume growth than ITC.
Apart from this, a big risk to the company is the illegal cigarette market. In order to contend with this and take advantage of the new category introduced by the Union Budget (sticks less than 65 mm in length), the company is test-marketing smaller filter cigarettes in Bihar and Uttar Pradesh. This should support volumes as these cigarettes are priced at Rs 2 per Capstan stick and Rs 2.50 per Gold Flake stick. Analysts say this move was expected as there is a tax differential of 40 per cent between the 64-mm and the 69-mm cigarettes. ITC’s distribution muscle could help it wrest some market share from the illegal cigarette segment.
While this development is largely positive, Edelweiss Securities expects limited volume impact (one to two per cent of total cigarette volume) due to the high price differential between the branded and the illegal segments. The contraband cigarettes are priced at Rs 1 per stick against ITC’s Rs 2 per stick. The market size for illegal cigarettes is Rs 1,800 crore and accounts for nearly 10 per cent of the industry. Another issue that worries analysts is that while entry into the new segment may help shore up volumes, this might dilute the gross margin profile.
Analysts are rather optimistic about the FMCG business, as it looks set to break even in FY13. The fall in input costs will help also help the company. What the Street really likes about the FMCG business is the focus on premium products. This seems to be paying off.
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