New draft law on minimum age a potential headwind for cigarette makers

Analysts view the development as negative for ITC, Godfrey Phillips and VST Inds

The central government, through the proposed Cigarettes and Other Tobacco Products (Prohibition of Advertisement and Regulation of Trade and Commerce, Production, Supply and Distribution) Amendment Act, 2020, seeks to raise the minimum age limit for sale of cigarettes and tobacco products from 18 years to 21 years, and restrict their sale within 100 meters of any educational institution. 

The draft Bill, piloted by the Union health ministry, also proposes to ban sale of loose cigarettes, increase fine on smoking in restricted areas to Rs 2,000 from Rs 200, and restrict advertisement (direct and indirect) of such products for personal consumption. If implemented in full, this could mean more troubles for India’s largest cigarette maker ITC and others like Godfrey Phillips and VST Industries. 

“If the draft Bill goes through, it will potentially cause further headwinds for the cigarettes industry. The proposed law, if enacted, will make it more difficult to add consumers and affect volumes as sale of only sealed and intact packs will be allowed,” said Abneesh Roy, research analyst, Edelweiss. 

Volume contraction and buzz of a GST hike in the upcoming Budget are additional headwinds for these stocks. “In our view, the possibility of GST hike in the Budget or (during) any of the GST council meets remains high given weak government finances amid the current Covid environment,” said Motilal Oswal Securities in a note. 

Though it has been diversifying its operations over the last 10 years, cigarettes remain the largest contributor for ITC, accounting for 85 per cent of its FY20 earnings before interest and tax (EBIT). Even in the 31-month period between July 2017 (GST increase) and February 2020 (National Calamity Contingent Duty increase) — when there was no GST increase on cigarettes —ITC's cigarette volumes and Ebit performance had been tepid.

Despite these proposals, the three stocks are up marginally over December-end close.

Weak enforcement of rules may limit the damage, while a crackdown on manufacture and sale of illicit cigarettes and tobacco products can benefit the bigger cigarette makers. “Sale of loose cigarettes is still widely prevalent in states where such regulation is already in effect. In our view, it will be difficult to monitor and implement this new law,” says Roy. 

He believes illicit cigarettes and tobacco products, which were thriving due to heavy taxes on legal cigarettes, will take a hit due to proposed stricter punishments. The growing illicit market has been impacting ITC's volumes for many quarters now. Beyond cigarettes, ITC's FMCG business has seen good gains in profitability and the potential remains strong. 

The pandemic hit-hospitality business should also see an improvement as the economy and travel activities improve.