ITC Ltd’s investors have no reason to celebrate. After all, so far in 2019 the stock has declined by about 15%. This compares miserably with the 9% gain in the Nifty 200 index.

A couple of factors have weighed on ITC’s shares. For one, investors are worried that taxes on cigarettes will increase, considering that the last tax hike was two years ago. Furthermore, global tobacco stocks have been derated a lot, said an analyst, adding that ITC’s valuations reflect that. “The primary reason for ITC’s derating during the last two years has been the lack of double-digit Ebit growth in cigarettes," analysts of Antique Stock Broking Ltd said in a report on 18 December. Ebit is earnings before interest and tax.

Additionally, intense competition in the cigarettes space has been a problem area, too. Note that the cigarette business growth is crucial for ITC, as the segment is a large contributor to profit. For the half-year ended September, cigarette Ebit formed nearly 85% of the company’s overall Ebit.

(Graphic: Santosh Sharma/Mint)
(Graphic: Santosh Sharma/Mint)

“Even though ITC is looking to become a more diversified FMCG company, the non-cigarette segments contribute very little to profits," said Nitin Gupta, analyst at SBICAP Securities Ltd. ITC’s fast-moving consumer goods products are finding it difficult to make a mark in the market and the company has to invest more in this segment, which can keep its margin profile in other-FMCG segment sub-par, added Gupta.

To be sure, ITC’s valuations are compelling; trading at 19 times estimated earnings for FY20, based on Bloomberg data. On the brighter side, downside risks appear limited at this level. The moot question now is what are the triggers. Hereon, investors will have to watch out for news flow on cigarette tax hikes. A few analysts say a reasonable increase in tax could be helpful for the company. “We believe that a moderate hike in cigarette duties after a gap could enable ITC to take meaningful price hikes, which in turn provides an opportunity to regain the double-digit Ebit growth and trigger a re-rating," said Antique analysts. Besides, better cigarette volume growth may fetch brownie points as well.

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