ITC: Will the rally sustain?

Though increase in excise duty on expected lines, there are no sustainable triggers for the stock

ITC scrip touched a new 52-week low of Rs 268 on Monday following the increase in excise duty on cigarettes in the Union Budget. However, the scrip recovered soon and was up 1.5% to Rs 295.25 as against a 0.6% fall in the S&P BSE Sensex.

While the FM said in his speech that excise duty on tobacco products is increased by 10 to 15%, budget fine prints suggest that excise duty has been raised by 10% on cigarettes which is in-line with street expectations of 8-10% hike.

"We believe ITC will have to hike cigarette prices by 8-10% in FY17 to pass on the higher excise duty. Cigarette volumes should be better in FY17 than FY16 where the excise duty was hiked by 13%," says Amnish Agarwal, Prabhudas Lilladher.

He has kept his estimates unchanged as the hike was in-line with his expectations. Most analysts believe ITC can comfortably pass on the 10% hike in excise duty and expect flattish to slightly negative volume decline in cigarettes volumes in FY17.

Notably, excise duty on cigarettes has been increased for five years in a row now though the quantum has been reducing every year. So while this metric was raised by 21% in FY15, it is now hiked by 10%.

Post these hikes,  ITC's cigarette volumes have fallen for 11 quarters in a row (ending December 2015 quarter). Continued hike in taxes on legal cigarettes has led to a sharp jump in consumption of illegal tobacco products in the country and hence leading to a lower growth in revenues (from cigarettes) to the exchequer. 

While the stock has witnessed some uptick on Monday, the worse is far from over.

"ITC is currently trading at 32% discount to the consumer pack. The valuation discount may continue as the Health Minister’s recent suggestion to evaluate possibility of a new sin tax is an additional overhang on ITC," says Abneesh Roy of Edelweiss Securities. Any harsh steps adopted by state governments against cigarettes and stricter regulations on the sector could also be a key downside risk for ITC. 
 

At current levels, ITC scrip trades at reasonable valuation of 21 times FY17 estimated earnings. While the company is aiming to achieve much larger scale in its FMCG business, analysts await sustained improvement in profitability to factor any improvement.