ITC: Despite price hikes, uncertainty remains high

Even as Street cheered price hikes, uncertainty on taxes under GST a key overhang for tobacco major

ITC's decision to raise prices in two of its cigarettes brands — Gold Flake regular (69 mm) and Navy Cut (74 mm) — by about 14 per cent was cheered by the Street, but investors should tread carefully given the uncertainty on taxes.
 

To begin with, the Street’s reaction is because the price hike can bring multiple gains for ITC. It will lead to higher operating profit margins in the cigarettes business. Second, it can help offset some of the fall in cigarette volumes arising from demonetisation. Third, the hike could also help ITC pre-empt a potential increase in taxes in the upcoming budget.

Abneesh Roy, consumer analyst at Edelweiss Securities, says, “Excise duty on cigarettes was raised by 10 per cent in the last budget and ITC needed around six-seven per cent price hike to pass it on. But ITC did not hike prices then. The latest increase in prices, which is more than required, thus indicates that it could be anticipating some increase in taxes in the upcoming Budget.” So, it was also overdue.

Nonetheless, the move, believe analysts, is an annual phenomenon as the company raises prices before and after the Budget to avoid any sharp price increase if duties are increased in any Budget. Cigarette sales have taken a hit after demonetisation and this hike could also offset some of the pressure.

“There will be up-stocking of old stock by distributors for March and April sales. This would give a boost to ITC’s Q3 numbers. There was a fall of 30 per cent post demonetisation in ITC's cigarette volumes which will now be partly offset,” says Sachin Bobade, consumer analyst at Dolat Capital. 

Other cigarette makers such as VST Industries and Godfrey Phillips too could follow in ITC's footsteps and increase prices, believe analysts. Stocks of these cigarette makers surged anywhere between four and 20 per cent on Tuesday as against a near two per cent rise in the S&P BSE Sensex. 

Another positive measure for these companies could be imposition of mandatory licensing of non-cigarette products such as beedis, hookah, khaini and the like. If implemented, this move will reduce the gap between these players (mostly unorganised) and the organised cigarette makers. 

While ITC stock is trading at inexpensive valuations relative to its peers in the consumer staples segment, investors must be cognizant about the uncertainty around taxation of cigarettes under the goods and services tax (GST) regime. Higher taxes have already impacted ITC’s growth rates, earnings and cigarette volumes in recent times, thereby reflecting on its stock valuations.

Tightening regulations around cigarettes could continue to weigh on ITC's valuations. Though the company has big growth plans for its other FMCG business, improvement in its profitability will happen at a gradual pace. Given that the cigarettes business continues to contribute more than 80 per cent to ITC's profitability, the stock will continue to move in tandem with the news flow around this segment.

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