ITC: Worst-case scenario may be factored in

Despite sharp duty rises, fall in tax collection from cigarettes. So, more rises could be gentler on the firm

Punitive tax regimes for cigarettes have proved a bane for ITC in the past. A sharp rise in duties in recent years has been no different. Duties have been increased by 15 per cent in each of the past four Budgets. Though ITC has raised prices to offset the increases, its volumes have taken a hit. After rising one per cent in FY13, it fell three per cent in FY14 and nine per cent in FY15. As a result, earnings before interest and taxes (Ebit) growth, the biggest contributor to ITC’s revenue and profits, has slowed from 18 to 20 per cent to two per cent in the June quarter.

Volumes are estimated to fall eight to 10 per cent in FY16.

Every time after such periods of volume contraction, volumes have recovered and so has the stock. Will this time be different? Analysts believe the worst is factored in. ITC’s current market price already factors in the worst-case scenario of a compound annual growth rate (CAGR) of minus six per cent in volumes and 16 per cent in excise duty over FY15-20, say Rakshit Ranjan and Ritesh Vaidya of Ambit Capital. The analysts, who have a buy suggestion on ITC, with a target price of Rs 395, expect catalysts to emerge from the second half of FY16, helped by a weak base and higher consumer demand. On August 19, Morgan Stanley analysts Nillai Shah and Indira Badrinarayan upgraded the stock to overweight. They said, “There are risks with respect to continuing adverse policy action, yet valuations and earnings expectations are relatively benign.”

While it is anybody’s guess how much more duty increases the central and state governments will undertake, history suggests increases beyond a level are detrimental. Led by the sharp duty increases in recent years, the market share of illegal cigarettes has increased from 12 to 13 per cent in 2009-10 to 18 to 20 per cent. Cheap Chinese brands have also made way into a few Indian cities, eating into the volumes of organised firms. Absolute tax collections are down. Analysts believe further duty increases will be benign.  

ITC continues to increase focus on its other businesses. It is reportedly looking at entering the dairy products segment, which among other categories is aimed at helping achieve its fast-moving consumer goods revenue target of Rs 100,000 crore by FY30 (CAGR of 17 per cent). An expected recovery in economic demand around end-FY16 should rub off well on its hotels and paper business.

While FY16 could see ITC’s earnings grow in single digit, these are estimated to grow 14 to 15 per cent during FY16 and FY17. Reasonably good to prop up sentiment.