Ban on e-cigarettes unlikely to hinder ITC's prospects; stock falls 1.2%

Down-trading by customers and overall slowdown are near-term challenges for the cigarettes leader

Finance Minister Nirmala Sitharaman’s announcement on the complete banning of e-cigarettes, including any other alternative smoking device, is unlikely to significantly affect ITC. 

The stock, which initially reacted positively on Wednesday, fell 1.2 per cent on Thursday to Rs 236.75, along with the benchmark indices.

Though ITC has its own e-cigarette variant — Eon — its revenue contribution is minuscule (not even 0.2 per cent, estimate analysts) and the chances of its contribution rising in the near term was almost negligible.

“E-cigarette is an expensive format that has not actually done well, even in developed nations, in terms of acceptance. Therefore, the e-cigarette ban should not be a material thing for ITC,” said Shirish Pardesh, analyst at Centrum Broking.

Analysts, on the contrary, expect the ban to be marginally positive for ITC in the long term, given this has eliminated competitive intensity from players like JUUL, to some extent.

However, what is more important for ITC is its traditional cigarette business, which has 80 per cent share in the domestic market and contributes 85 per cent to operating profits. The expected down-trading by customers in traditional cigarettes, owing to the consumption slowdown, is what seems to be making the Street cautious.

“In the current scenario, low-priced cigarettes are gaining more traction. People are likely to have shifted from higher-priced brands to lower ones,” Pardesh added.

Therefore, though ITC might see an uptick in cigarette volumes, it may come at the cost of gross margins. Some margin support, however is expected from cumulative price hikes of close to 3 per cent taken in the previous two quarters.

In the June quarter (Q1), price hikes and the overall slowdown hit cigarette volumes, which grew an estimated 3 per cent despite a lower base (1.5 per cent growth) in the year-ago quarter. 

However, margins expanded by 145 bps after three quarters of decline.

Overall, how the firm manages its cigarette volumes and profitability, along with how its other FMCG businesses (personal and household care, packaged foods, etc) pan out, will be important.

With some positive indications on these fronts, investors can consider the stock —currently trading at an attractive valuation of 19 times its FY21 estimated earnings, as against 45-50 times in case of FMCG peers.