With only 6% hike in excise duty, ITC cheers Budget 2017

Tax increase is lowest over the past six years but inclusion of sin tax in GST regime a key overhang

The Budget has provided multiple reasons of cheer for ITC. Prior to the Budget announcement, the ITC scrip was expecting an 8-10 per cent increase in duties on cigarettes. The actual hike has come in much lower at 6 per cent (including additional duties).

The tax rates on tobacco, pan bidis, etc has also been increased in the Budget meaningfully. For instance, the duty on pan masala has been hiked by 300 basis points to 9 per cent and that on unmanufactured tobacco has been hiked by 410 basis points or nearly doubled to 8.3 per cent. This is also positive for ITC as it will create a level playing field between the cigarette players and these unorganised players and also aid migration of consumers towards cigarettes.

"Increase in excise duty of Paper rolled bidis from Rs 21 per 1,000 bidis to Rs 78 per 1,000 bidis and Handmade Paper rolled bidis from Rs 21 per thousand bidis to Rs 28 per thousand bidis addresses a long term concern of ITC that only 'cigarette manufacturers bear majority of taxation of the tobacco industry'," says an analyst at Spark Capital. We believe tax rates are adjusted with a view to converge them to a common GST rate, he adds.

Most analysts believe that ITC can comfortably pass on the 6 per cent increase in excise duty to the end consumers without hurting volumes meaningfully. It is not surprising in this scenario that the ITC stock made a new 52-week high of Rs 269 a piece on Wednesday. 

Although the stock trades at attractive valuations of 26 times FY18 estimated earnings, investor sentiment around it is still cautious. This is because of a few key overhangs. One, there is a continued uncertainty on the taxation of cigarettes under the goods and services tax or GST mechanism. A sin tax on cigarettes and/or additional cess will be key negatives on ITC's cigarettes business which still generates over 80 per cent of its profits. This will be a key overhang on the stock in the foreseeable future. Additionally, though the company has stepped up focus on its FMCG business and believes it will scale up significantly going forward, this business continues to post choppy profitability and has posted the loss in the latest December quarter. A key long-term benefit from GST though is that it will provide a level playing field between organised and unorganised players in the industry and provide an edge to ITC's  cigarettes business in particular. 

Overall, in this backdrop, even if the key event of Budget is behind, investors should be cautious on the ITC scrip going forward.