The ITC Ltd share has a resigned air about it as the budget day nears, as investors fear cigarettes may be hit by another round of excise duty hikes. The past few weeks have seen the share underperform the BSE FMCG index as well as the broad market. The surprise then, really, would be if it is spared an aggressive hike. In the past one year, the stock is down 26%, while the FMCG sector index is down by 17.2%.
Excise duties on cigarettes have been hiked in four consecutive budgets, knocking cigarette companies down every time they began to recover from the after-effects of the previous hike. ITC has protected its margins hitherto, passing on the full price hike to customers and reshaping its product mix to sell more premium products. Volume growth has suffered, however, as consumers shifted to cheaper products— or if ITC were to be believed, to smuggled cigarettes.
A Mint report on 24 February said retail cigarette prices have already gone up anticipating the hike and that stock market analysts are pencilling in an 8-10% hike in duties. That would not be considered a bad thing, especially if the increase were around the 8% level. The fear is if the government takes the duties up by a much higher quantum, say a 15% increase.
In ITC’s case, cigarette volumes have been hit hard, with an estimated 12% decline in volumes in FY16 as per an Edelweiss research report. What’s worse, its much feted profitability is also under pressure. In the December quarter, the cigarette segment’s profit margin declined by 1.6 percentage points over a year ago. That is a concern.
There are two main triggers to watch for in FY17. A moderate hike in excise duty is likely to be welcomed. The second one is up in the air, really, at this moment. Broad urban consumption trends signals a revival may be in the works. What is common to buying shampoos and cigarettes? Nothing.
Some years ago, cigarette consumption was considered to be relatively price-inelastic. Indeed, smokers puffed through price hikes without noticing it. But steep successive duty hikes and the price hikes that followed appear to have—at least temporarily—damaged this inelasticity. Affordability has become an issue. So, if urban incomes turn healthier, affordability should improve, which may in turn influence demand. Price may not be the only reason for declining volumes and maybe the anti-smoking efforts are also succeeding. That is another angle to this story. For the moment, the severity of the likely excise duty hike is rightfully hogging all the attention.
The writer does not own shares in the above-mentioned companies.