Investors in ITC Ltd are unlikely to worry about higher excise duty on cigarettes this year. In last fiscal’s Union budget, the government had hiked excise duties by a hefty 17%, making investors skittish. But ITC was never in any real danger. It hiked prices to cover the higher costs and to add to margins as well.
After three quarters of fiscal 2011, adverse effects are conspicuous by their absence. Cigarette sales are up by 14% over a year ago, and segment profits are up 17%.
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ITC’s formidable position in the cigarettes market, and the inelastic nature of cigarette consumption, allows it to pass on cost hikes, with no permanent damage done to consumption. Its main threat is from strong competition, which seems remote after the ban on further foreign direct investment in tobacco.
If there is one problem ITC has, it is the cash pile it generates annually, with net cash from operations at Rs 4,630 crore in fiscal 2010. In the past, it has diversified into paper and hotels. But its biggest gamble is the consumer business, where the firm has entered segments as diverse as incense sticks to shampoos. The firm’s strategy appears to be in as many categories as possible and build critical mass in all of them.
That has meant that the business still does not make profits: in fiscal 2006, revenue was Rs 1,012 crore and losses Rs 172 crore, and in the April-December 2010 period, revenue was Rs 3,159 crore and losses Rs 230 crore. The urgency to make this business profitable is not evident. Perhaps there’s no need to hurry. ITC’s overriding goal may be to build a very large and fast-growing non-cigarettes consumer products business. And one day, people may think of it as a large consumer company, which also makes cigarettes.
With the cigarettes business earning margins in excess of 55%, the combined consumer business will still be profitable. And if at some stage the rhetoric against local cigarette companies reaches the level it has in Western countries, ITC can point to these more benign (and maybe even larger) parts of its business in its defence.
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