Cigarette maker ITC shares plummet after tax rate hike

MUMBAI (Reuters) - Shares in India's tobacco firms slumped on Tuesday, with market leader ITC Ltd recording its biggest daily percentage drop in more than two years, after the country hiked taxes on cigarettes in a surprise move.

The tax increase was achieved through the imposition of a special duty, and prompted analysts to downgrade stocks of tobacco companies. The move was seen signalling a tougher government stance towards the tobacco sector at a time of growing scrutiny of the health hazards of smoking.

The higher tax rate is part of a new Goods and Service Tax (GST) unveiled on July 1 in the country's biggest tax reform in the 70 years since its independence.

After the GST was rolled out, the tax burden on companies was reduced. Finance Minister Arun Jaitley on Monday said that had resulted "in a windfall profit" for cigarette makers, prompting the government to announce the special duty.

Deutsche Bank estimates the new rate will hike cigarette prices by an average of 16 percent. However, exact estimates are difficult given cigarette prices can differ from state to state.

CLSA, a brokerage, said it was being "forced to downgrade" ITC to a "sell" rating from "buy", while Credit Suisse cut its rating on the stock to "neutral" from "outperform".

CLSA said ITC would likely have to increase prices of cigarettes by 4-9 percent to protect its profit margins.

"We are really surprised with the move given government's view of maintaining tax neutrality," CLSA said.

Investors were also spooked by worries of increased scrutiny of the tobacco sector.

Deutsche Bank analysts said the move "potentially indicates the return of government's hawkish stance towards cigarettes".

"It appears that moralistic views on reducing cigarette consumption appear to be prioritised over economic value of optimising tax collection."

ITC shares plunged as much 15 percent to a 2-month low of 276.40 rupees. They were down 12.6 percent as of 0952 GMT, heading for their biggest fall since March 2, 2015.

Smaller rival Godfrey Phillips India Ltd fell as much as 10.4 percent, while another smaller cigarette maker VST Industries Ltd lost as much as 8.3 percent.

($1 = 64.3325 Indian rupees)

(Reporting by Abhirup Roy; Editing by Rafael Nam and Himani Sarkar)