Status quo on excise rates brightens ITC’s prospects for FY12

Status quo on excise rates brightens ITC’s prospects for FY12

ITC Ltd’s share price had declined after its December 2010 quarter results were declared, a period in which the markets also fell.

But it also seems that the markets were bracing for an increase in excise rates for cigarettes. With the government deciding to maintain excise rates, ITC shares have risen by over 10% since the budget announcement.

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Surely, this was not entirely unexpected, as it is rare for a government to hit the sector with a high levy in successive years. In last year’s budget, excise duties on cigarettes were hiked by about 17%.

But even back then, ITC did well to offset the impact of higher excise rates. The company sprung into damage control, exercising its famous pricing power, launching new products and ensuring that margins improved.

The excise hike robbed about 5 percentage points from ITC’s sales growth in the year till December. But that didn’t stop the company from growing operating profit by about 20%.

Besides, volume growth is returning gradually. Cigarette sales were already buoyant in the December quarter, rising by about 16% compared with 13% in the first half. For the nine months period ended December, the company’s earnings before interest and tax rose by 19.3%, slightly higher than the 17% rise in net revenue.

Now that fiscal 2012 (FY12) will not see an excise shock, it will be business as usual for ITC.

There were smaller irritants in the budget, such as service tax on hotels, excise on branded garments and on packaged food products. These will lead to some increase in costs, which will be passed on to consumers.

But all eyes are on its cigarettes business. Price hikes in FY12, after compensating for any increase in input and other expenses, will directly reflect in higher profits.

Cigarettes’ share of segment profits went down by 2 percentage points to 81% in FY11, and can be expected to trend higher in the next fiscal. Forecasts of robust economic growth mean that disposable income will continue to increase, which should benefit the company.

ITC’s share trades at about 24 times its FY12 earnings per share, based on consensus estimates. That factors in an earnings growth of about 17%, which appears conservative. Its net profit has risen by 22% in the year so far, despite higher excise duties on cigarettes. That explains why its share price has recovered so sharply.

Graphic by Sandeep Bhatnagar/Mint

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