ITC Ltd is feeling the full brunt of four successive years of tax increases on cigarettes. Its volumes are estimated to have dropped by about 17% year-on-year (y-o-y) in the June quarter. This is the highest rate of decline ever in at least the last 15 years, according to an analyst with an institutional brokerage.

The pressure on sales has had a telling effect on the company’s valuations as well. In end April 2013, just before Unilever Plc announced a voluntary open offer to increase its stake in its Indian subsidiary, ITC’s market capitalization was as much as 2.5 times that of Hindustan Unilever Ltd. The differential has now nearly halved to 1.27 times.

While Unilever’s increased interest in its Indian operations, coupled with stellar growth in FY14, had a role to play, the main reason the valuation gap has narrowed is the constant pressure on ITC’s cigarette sales owing to successive hikes in taxation.

The company said in a press release, “The punitive taxation regime on legal cigarettes in India was exacerbated with two rounds of sharp increase in excise duty—in July 2014 and February 2015... Over the last three years, the incidence of excise duty and VAT (value-added tax) on cigarettes, at a per-unit level, has gone up cumulatively by 98% and 104%, respectively. The combined impact of such sharp increase in excise duty and VAT is exerting severe pressure on legal industry sales volumes."

Of course, despite all this, the company has managed to report a 3.3% y-o-y increase in earnings before interest, tax, depreciation and amortization. Thanks to price hikes, the decline in revenues of the cigarettes division was contained at 1.2%, while the segment’s operating profit margin rose handsomely, resulting in a 2.2% growth in profit. This was lower than most analysts’ estimates—for instance, analysts at Kotak Institutional Equities had estimated a 6% growth in profit on the back of a lower 15% decline in volumes.

Despite ITC’s many attempts at diversification, cigarettes still account for over four-fifths of total profit. It’s little wonder investors are disappointed at the meagre growth in the segment, even though cumulative profit of other segments rose by 23.4%.

Interestingly, ITC shares jumped 4% on Thursday, after the results were announced. But analysts say this is either on account of a covering of short positions or to do with some technical reasons related to the expiry of derivatives contracts for July. Hardly anyone is excited about ITC’s prospects.

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