In about a month from now, cigarette companies and their investors will know if their fears were unfounded. The Union budget will reveal if cigarettes will be taxed again. ITC Ltd, the market leader, has seen its volume growth affected in the near term following a sharp hike in cigarette prices. It had passed on the impact of higher duties levied in the 2012-13 budget to consumers, in addition to its regular price hikes.
The December quarter, however, has seen a revival of sorts, as volumes during the quarter grew by 2-3%, compared with a 0.4% increase in the preceding quarter, according to a Reuters news report. That affirms the price inelasticity in cigarette consumption, and that the impact of price hikes is more visible in the near-to-medium term.
ITC’s business profile is more broad-based now, but cigarettes remain central to its profits. This business accounted for 83.8% of its segment profits during the December quarter though it contributes a relatively lower 43.3% of sales. The segment’s sales rose by 13.1% to Rs.3,657 crore over a year ago, while its profit rose by 21.1% to Rs.2,234 crore. Margins improved by over 4 percentage points on a sequential basis, but were down by 38 basis points (bps) from a year earlier. One basis point is 0.01 percentage point.
Its consumer products business continues to do well though ITC’s desire to keep spreading this business out, both in terms of new categories and markets, meant that it still made a small loss. This business grew by 30% in revenue terms and now contributes about a fifth of sales. It is doing a fine job of propping up sales growth while cigarettes hold fort on the profitability front.
In the December quarter, the trading business also played a key role in propping up overall sales growth, as its sales rose by 43%. Hotels and paper were affected by the economic slowdown. ITC’s operating profit margin declined by 89 bps, perhaps due to the higher contribution to revenue of the relatively less profitable trading business.
In the year ended December 2012, ITC’s sales rose by 19.4% while its net profit grew by 20.7%. Its share trades at a price-to-earnings multiple of 25 times its consensus FY14 earnings per share, according to estimates polled by Thomson Reuters.
That is not cheap, but is not unusual for ITC, especially considering that sales growth of cigarettes by volume is reviving and consumer products sales growth remains high. The key risk in the near term is if the government decides to tax tobacco products yet again in the budget. That could affect volume growth yet again, even if only for a few more quarters.