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Event update: ITC (Neutral) - Sharp NCCD hike to dent cigarette volumes

Event

The Union Budget 2020 has hiked National Calamity Contingent Duty (NCCD) on tobacco products, including cigarettes (across sizes). The new NCCD is applicable from of 02 Feb 2020.

Key details

• NCCD on filter cigarettes of size upto 70mm has been increased to Rs440 per thousand sticks from Rs90 currently. For length between 70-75mm, NCCD has been increased to Rs545 per thousand sticks from Rs145. For longer cigarettes, NCCD has been increased to Rs735 per thousand sticks from Rs235 currently.
• NCCD has also been increased from 10% to 25% across various other tobacco products such as Hookah, chewing tobacco, Jarda, snuff amongst others while NCCD on smoking mixtures for pipes and cigarettes has been increased to 60% from 45%.

Our view

Overall taxation on cigarettes is being increased after 10 quarters of tax sanity (though there was a meagre increase after cigarettes were brought under the excise net in the 2019 union budget). We believe that the tax incidence, for ITC, would increase by ~13% on a weighted average basis. This would entail a 7-8% price hike to off-set the impact of higher taxation, in our view. In isolation, cigarette demand can be construed as inelastic but India’s cigarette pricing is amongst the highest in the world relative to median per capita income. As a result, a price hike usually dents demand. Moreover, it would accelerate the share loss of India’s organized cigarette industry to smuggled/illegal cigarettes as price differential widens. We now build a volume decline of 4% in FY21E, for ITC, versus 4% growth earlier and a net realization increase of 2% (versus 3% earlier); in FY22E we build a 6% volume growth (on a low base) and net realization improvement of 1%. This leads to a cut of 6%/5% in our FY21E/22E EPS. We were valuing ITC’s cigarette division at 17x earlier but now lower it to 15x FY21E given lack of volume growth visibility in near-term. We also note that ITC’s cigarette EBIT growth is not very different from its larger global peers (Altria, Philip Morris International, BAT) and our target multiple of 15x is still an avg. premium of ~25-30% to their FY21E PE multiples. Post our downgrade, the stock has corrected 17% and while downside is limited from here on, we maintain Neutral rating given lack of positive triggers.