ITC's market cap crosses Rs 4 lakh cr on GST trigger: Should you buy?

ITC Ltd hit a high of Rs 354.8 on the National Stock Exchange (NSE) in intra-day deals on Monday with its market-capitalisation (m-cap) crossing the Rs 4-lakh crore mark. Of the 294-point gain in the S&P BSE Sensex at 2:30pm, ITC’s contribution stood at a huge 172 points, BSE data show.

The rally in the counter comes on the back of implementation of goods and services tax (GST) bill last week, which analysts say, is likely to positively impact the company going ahead given the changes in the tax structure for cigarettes.

ITC, which also operates in branded packaged foods, hotels, paperboards, agri-related products among various other businesses, derived nearly 62.7% of its FY16 turnover from the cigarettes business segment, AceEquity data show.

Analysts at Nomura, for instance, believe that tax incidence for ITC’s cigarette segment under the GST regime is likely to come down due to removal of dual taxation. Earlier, value added tax (VAT) was applied on the MRP, which included excise duty as well. This, Nomura, believes, could see a possible price reduction in the range of 5-6%, which could boost cigarette volumes.



Another positive for ITC's cigarette business segment, according to analysts, is the recent government notification that there will be no levy of any additional duty of excise on cigarettes. However, there is no clarity yet on whether the current 'National Calamity Contingent Duty' (NCCD) will be levied in addition to the GST.

In the scenario that NCCD is levied at the existing rate, Nillai Shah and Indira Badrinarayan of Morgan Stanley expect around 4% reduction in cigarette taxes and around 2% price flexibility for ITC. 

"However, in the event that NCCD is not applicable on cigarettes, we see a higher 7% reduction in cigarette taxes and around 3.5% price flexibility. We note that under GST, tax incidence on the supply chain will rise, which would mean that ITC will increase distributor margin by around 2 percentage points," they said in a recent note on the company.

They expect the stock to react positively to this development, even as clarity on NCCD is likely to emerge over the next few days.

“The debate on government tax policy on cigarettes has been turned on its head – investors expected the government to be particularly harsh on cigarette consumption, but it now appears that a spurt in illicit cigarette trade and a shift in favour of less tax-efficient forms of tobacco may have challenged the popular notion of a relatively easy increase in tax collection from the category – leading to a look beyond the obvious health concerns,” they add.

Given the recent rally in the stock, analysts now remain cautious on the stock. Thus far in calendar year 2017 (CY17), ITC has gained around 43% as compared to 17% rally in the S&P BSE Sensex and 32% rise in the BSE FMCG index.

“I don’t think the stock merits an investment at the current levels. It has run up too fast, too soon. That apart, there is no guarantee that the government will not increase the tax on cigarettes going ahead. Moreover, the company’s other businesses are also not doing exceedingly well,” cautions G Chokkalingam, founder and managing director of Equinomics Research & Advisory.

Despite all positives and remaining overweight on the stock, Morgan Stanley has a target price of Rs 310 on ITC’s stock. Nomura, on the other hand, sees an upside potential of 14% from its recommended buy price of Rs 311 in its June 30 report.

Exhibit 1: Scenario outlining potential fall in cigarette taxes under GST
KSFT cigarettes - Current structure	Rs per stick
Retail price - current	14
Distributor margin (assumed at 10%)	1.4
VAT	2.4
ITC gross revenues	10.2
Excise	4.4
ITC net revenues	5.7
Tax paid by distributor	2.7
Less offset	2.4
Net tax paid by distributor	0.3
Net distributor margin	1.1
Total Tax under current structure	7.1

KSFT cigarettes - Under GST
Scenario 1
ITC net revenues (Similar to current net revenue)	5.74
GST - Specific component (with NCCD)	4.4
GST - Ad Valorem component	1.9
Distributor Invoice value	12
Distributor margin (assuming more than 20% increase by ITC)	1.7
Tax paid by distributor	0.6
Net distributor margin (similar to current margin)	1.1
Retail price	13.7
Around 2% price flexibility; around 4% fall in tax incidence
Total tax paid under GST	6.9

Scenario 2
ITC net revenues (Similar to current net revenue)	5.74
GST - Specific component (without NCCD)	4.2
GST - Ad Valorem component	1.9
Distributor Invoice value	11.8
Distributor margin (assuming more than 20% increase by ITC)	1.7
Tax paid by distributor	0.6
Net distributor margin (similar to current margin)	1.1
Retail price	13.5
Around 3.5% price flexibility; around 7% fall in tax incidence
Total tax paid under GST	6.6

Table Source: Morgan Stanley research report
Note: GST (specific and ad-valorem) based on GST schedule