ITC Rating: Buy; Only smoke, not fire

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Published: April 13, 2015 12:07:03 AM

Excise duty hike is not that negative for the cigarette major

Event—cigarette taxes increase 16%: The Union Budget has increased the basic excise duty (BED) on all lengths of cigarettes by 15%, and on the <65mm micro filters by 25%. Overall we estimate the weighted average increase in excise on cigarettes is +16% for FY16e.

We believe ITC will take staggered price increases to pass this on, but we have cut our volume estimates to -5% for FY16e, primarily estimating a decline in micro-filters (price sensitive) that is seeing a large price increase and small price change for regular filters.

We think the King-size portfolio can absorb higher prices, but the price point of R10/stick would have to be increased to R12/stick—we need to watch out for consumer reaction to this.

The micro-filters are now priced between R3-4/stick and this would need to be increased to R4-5/stick given the 25% excise duty increase; affecting consumption in this segment. Most of our volume decline is estimated to come from this segment.

ITC

Impact—government viewing tobacco holistically, positive: Cut and raw tobacco excise duty has been increased from R60 to R70/kg which should hurt affordability of basic products i.e. ‘beedis’. We estimate the raw material and labour cost should account for 50% of beedi COGS (cost of goods sold) which is under an inflation spiral (since labour inflation has been ~10-15% p.a.) Further the excise duty on chewing tobacco sachets was determined on the capacity of the packaging machine, now amended to include the speed and other criteria to help account for unaccountable volume in the market. Cigarettes account for just 12% of tobacco consumed in India, but contribute to 85% of tobacco excise collections.

Stock-perfom

Earnings & price target cut by 2-3%: While white cigarette volume visibility has been pushed out, a more action-oriented approach to taxing the substitutable chewing tobacco is a positive. With an all-round improvement in the economy and urban consumption, ITC should be a gainer, in our view.

Valuation—reiterate Buy rating: We cut our sum-of-the parts price target to R430. At our price target ITC’s cigarette business would be valued at 24x with R20 attributable to the now breaking even consumer staple business. At 25x PE (price-to-earnings), ITC would be trading at its five year average PE.

We cut our revenue estimate by 1% and EPS (earnings per share) estimate by ~2.3% for FY16e. Our price target is a sum-of-the-parts of the DCF (discounted cash flow) of the core business (value reducing from R430 to R410) and the value ascribed to the now-breakeven consumer staples business (i.e. R20 per share remaining unchanged). We now bring our price target down from R450 to R430.

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