The cigarette industry, they say, is a friend of the finance ministries because they have often turned to the industry for revenues. This year too, excise duties on cigarettes have been upped in the Budget for 2010-11. And it has been a fairly big blow for cigarette makers like the Kolkata-headquartered ITC because the hike is in the region of a weighted 15% ? far larger than expected.
As brokerage CLSA says, ?This is much higher than the earlier expected 5-7% hike.? The ITC management, of course, can?t believe it has been dealt such a big blow. ?This is a steep increase. We are evaluating the impact on our costs and based on that evaluation, we will look at pricing strategies,? a spokesperson says. The ITC stock lost 6% to Rs 232 following the announcement, but recovered soon and has since stabilised at around Rs 249 on the Bombay Stock Exchange (BSE).
Cigarettes that have a length of between 60-70mm, the regular segment, have seen an excise duty increase of 18%. This segment, comprising brands such as Bristol, Gold Flake, Scissors, Flake and Capstan, accounts for approximately 60% of ITC?s cigarette volumes. The excise duty on longs and the king size filter versions have seen a hike of 11%. Clearly, ITC will need to pass on a part of the hike and that will hurt volumes. Deutsche Bank, (Global Markets Research) notes, ?Every double-digit hike in excise had led to a decline in volume and we expect 2011 to be no different.? The brokerage points out that historically ITC has sacrificed volumes but maintained per-stick profitability, and that a hike in the excise duty is relatively better than a higher VAT. According to HSBC, ?ITC has a very good track record of managing tax hikes. As the price elasticity of demand for cigarettes is low, ITC has substantial pricing power and has previously managed to pass on tax hikes, so the bottom line has been protected.?
JP Morgan points out that ITC has taken some price increases across most of its cigarette portfolio and adds that the price increase has been a weighted 10%. That, the brokerage feels, is largely in line with its expectations and should be more than adequate to neutralise the impact of the excise increase. Analysts say ITC is expected to pass on some more of the increase in phases. Given that volumes may not grow at levels that had been earlier pencilled in, analysts have been compelled to take a re-look at the earnings and IDFC ? SSKI says it would take a fresh look at the earnings for 2010-11, which may be revised downwards from the current number of Rs 12.8 per share. HSBC says it is revising earnings estimates by just 2% downwards, and assumes that volumes would remain flat in 2010-11 compared with 8% currently.
The blow from excise duties apart, analysts are also waiting to see if any state governments will increase the VAT. That would have a further impact on prices. In the past few months, ITC has had to deal with higher VAT (valued-added tax) rates on cigarettes in the states of Maharashtra, Delhi, Rajasthan and Pondicherry. For the quarter ended December 2009, ITC reported net revenues from the cigarette business of Rs 2,332 crore, a substantial increase from Rs 1,994 crore in the corresponding period of the previous year. That increase came in on the back of better realisations due to price hikes and an improved product mix.
The price of a cigarette is determined with respect to its length. For example, pre-budget, for a filter length cigarette not exceeding 70 millimetres (mm), the price was Rs 819 per 1,000 sticks. The post-budget-hike results in an effective increase to Rs 969 per 1,000 sticks. Hence, a difference of 18% is the resultant hike in prices. However, the government has created a new segment of filter cigarettes that are shorter than 60mm and it is possible ITC will launch a product in this segment ? either a new brand of a variant of an existing brand. Also, the government has increased taxes on chewing tobacco, so it is possible that consumers of chewing tobacco might switch over to cigarettes.