ITC gains 1.2% after worst fall in two decades. Is the worst over?

Here's how brokerages and research houses have reacted to the govt's move to hike cess on cigarettes

ITC rose marginally on Wednesday morning, gaining 1.3% or Rs 3.3 to Rs 287 levels, after the stock witnessed its sharpest fall in nearly two decades – down 13% on closing basis – on Tuesday. The fall came after the Goods and Services Tax (GST) Council, on Monday, increased cess on cigarettes. 

The development saw brokerages revise their FY18 earnings estimates and the price target for ITC’s stock. Here is a quick compilation of what they said.

NOMURA

While the news is a negative for the company and will require some re-strategizing on the pricing front, we believe that the long-term story remains intact. We maintain our Buy rating and would advise investors to use the correction as an opportunity to add the stock to their portfolio. Our sum-of-the-parts-based Rs 389 target price implies around 20% potential upside. The shares currently trade at a P/E multiple of 26.7x on our FY19F EPS of Rs 12.19.

Also Read: GST: Modi govt raises tax on cigarettes

JEFFERIES

The changes would now raise overall tax incidence by 20-30%, impacting retail prices by 11-14% (all else being equal) and leaving them 1-6% higher than pre GST levels. This could weigh on ITC, trading at 36x FY18 P/E on consensus forecasts.

EDELWEISS RESEARCH

Government’s move to hike taxes to more than pre-GST levels brings to fore its negative stance on the sin sector. Finance Minister mentioned in his speech that the government proposes to reverse the windfall gain being garnered by cigarette companies. Even if this policy gets partially rolled back, uncertainty would still loom large over the taxation policy for cigarette companies.

With per capita consumption 1/18th of China’s, cigarette opportunity in India remains attractive over the long term. Negative surprise on taxation front coupled with uncertainty will keep the stock under pressure. We value ITC on sum-of-the-parts (SoTP) basis on FY19E and arrive at a target price of Rs 304. We downgrade to ‘HOLD/sector performer’ from ‘BUY/sector outperformer’.

AMBIT CAPITAL

ITC’s stock price reacted sharply to the hike in tax on cigarettes. The hike is negative for ITC’s near-term earnings and erodes confidence on predictability of cigarette taxation. However, ITC’s long-term strengths are intact: 1) market share dominance, 2) likely positive cigarette volume growth, and 3) rising profitability. 

Moreover, the net tax hike of around 13% in FY18E is in line with last 5 years’ average tax hike. Hence, though the near-term tailwinds of benign taxation have disappeared (FY18E EPS cut by 5%), the long-term outlook for ITC remains unscathed. We have cut our DCF-based target price to Rs 320 from Rs 340 to factor in the earnings downgrade. ITC is trading at 25x FY19E P/E; the around 30% discount to the FMCG sector is unjustified given the inherent strengths of ITC are intact.

ICICI SECURITIES

We believe ITC would need to take a price hike of around 12% to pass on the additional tax burden. We change our volume estimates from earlier 4% to 1% for FY18E and simultaneously change our realisation estimate from 5% to 12%. For FY19E also, we are revising our volume estimates downwards from 4% to 1%.

In a scenario where volume growth would continue to remain under pressure, we assign lower multiple to cigarettes business of 30x against 35x earlier. We value the cigarettes business at Rs 247 (PE multiple of 30x FY19E EPS), FMCG at Rs 44 (4x MCap/sales FY19E), paperboards at Rs 4 (3x FY19E EV/EBITDA), agri-business at Rs 6 (3x P/BV FY19E) and hotels at Rs 7 (2x EV/room FY19E) and also add the cash per share of Rs 10. We downgrade ITC to HOLD with a target price of Rs 317.

MOTILAL OSWAL RESEARCH

Until now, we were expecting price reduction and volume growth; however, post the revised GST rates, we expect ITC to take a price increase to pass on the impact of the higher effective rates. We have reduced FY18/FY19 cigarette volume growth forecasts from 6%/7% to 3%/4%.

We reduce our EPS forecasts by 4%/11% for FY18/FY19, and also cut our target multiples to 26x June 2019E EPS (10% discount to three-year average) from 31x earlier. This results in revised target price of Rs 280 (Rs 380 earlier) and rating downgrade to Neutral.