Tobacco consumption in India is c.60% of the world average; however, per capita consumption of cigarettes is c.11% of the world average. Excise duty increase on cigarettes has hurt volumes in the past; cigarette taxes in India are now 14x vs. the US, 9x higher vs. Japan and 7x higher vs. China. Government’s proposal to bring manufacturing of other tobacco products under the ambit of licensing is the apt move to control tobacco taxes.
New licensing policy for tobacco under consideration
Government is considering a proposal to bring manufacturing of “Other Tobacco Products” such as tobacco blended Pan Masala, Bidis and other chewable tobacco related items under the ambit of compulsory licensing. Currently five industries are under compulsory licensing, including cigarettes where no new fresh licence has been issued since 1999. It’s mandatory to obtain licences before setting up such industries.
A positive development for cigarette industry
Cigarettes account for c.11% of the total tobacco consumption in India, vs. c.24% in 1981-82. The balance includes bidis and smokeless tobacco (market share equally split, according to our estimates). Excise duty differential between cigarettes and other tobacco products widened from 29x to 53x in the past 10 years, with most of the smaller players managing to evade taxes. A compulsory licensing of all tobacco manufacturing units would ensure a level playing field for cigarette manufacturers and ensure long term conversion opportunity from other tobacco products to cigarettes.
Implementation a challenge
None of the bidi manufacturers command more than 5% market share, with c.80% of the production happening through the unorganised sector. The nature of the industry implies implementation of licensing requirement would be a mammoth task.
We arrive at our PT of Rs 298.60 for ITC by using a sum-of-the-parts (SoTP) valuation. The cigarette business contributes Rs 231 to our fair value (arrived at by a DCF), while other FMCG businesses contribute R48.7 (valued at 5.5x EV/Sales), Hotels Rs2.9, Agri
Rs9.2 and Rs6.4 is contributed by
the Paper business.
The proposed GST framework is a potential negative for ITC if the combined incidence of Excise Duty and GST are not revenue neutral.