Total worldwide cigarette volumes declined 2.1% y-o-y to 5.5 trillion sticks in CY15, the biggest year on year decline in more than two decades, according to data from Euromonitor. While volumes declined in Asia Pacific, Australasia, Latin America and Eastern Europe for Western Europe, the Middle East and Africa registered positive volume growth.
Decline largely driven by the China market
The China tobacco market (accounting for 45% of total world volumes) was affected by a wholesale excise rise from 5% to 11%, increased state control on production, and greater health awareness in some regions. Volumes declined by 2.4% in CY15. This situation does not seem to be temporary–Euromonitor projects a loss of 5% in volume terms for China between 2015 and 2020.
Largest decline in India in CY15
According to Euromonitor, cigarette volumes declined 8.2% y-o-y to 88 billion sticks in CY15 in India. This 8.2% decline is the biggest y-o-y decline in the last 15 years, even though volumes have been declining since 2011. As a result of this volume decline, value growth for the cigarette industry in India for CY15 is a dismal 1.9% compared to a five year average of 10.3%, indicating that the industry may be in structural decline.
Expect a boost in volumes for FY17F driven by ITC’s pricing strategy
In response to the 10% hike in excise duty by the central government and a 5-15% hike in VAT by a few state governments, ITC has only increased prices by 13% at the premium end of its portfolio translating into a weighted average price hike of 7.6%, the lowest in four years. This makes us optimistic of a boost in volumes for the company this year, after a constant decline over the past two years. We however, do expect the company to take increase prices in FY17F as well.
Long-term outlook is negative
Compared to other countries, India still imposes one of the lowest excise duties, and we believe this situation is bound to change. Apart from previous excise duty increases and potential of greater excise duty hikes in the future, larger pictorial warnings on packs and a ban on the sale of loose cigarettes in certain states are challenges that the company is facing currently. The possible implementation of a 40% goods and service tax (GST) continues to be an overhang. However, most risks seem priced into the stock, and we maintain our Neutral rating with a target price of R316.
Our TP is derived using a sum-of-the-parts (SOTP) valuation methodology. We value the core cigarette business at P/E of 17x on FY18F earnings. Our other SoTP valuations include: hotels at 20x; paper at 8x EV/Ebit; new ventures at 3x sales; agri at 1x sales; and cash and liquid assets of R20/share. A higher-than-required additional price hike would hurt volumes and Ebit growth, posing a downside risk to our estimates. Lower-than-expected increases in taxes on cigarettes are the key upside risk to our view and estimates.