ITC: Signs of ‘predictable taxation regime’, probably::

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ITC (ITC)
Consumer products
Signs of ‘predictable taxation regime’, probably. There is near-consensus that the
central budget could potentially see significant excise increase for cigarettes. We agree.
However, we differ on the potential impact on ITC. Considering the addictive nature of
cigarettes and the associated consumer behavior, predictability in taxation (and hence
calibrated price increases) is the key for industry volumes. Channel sources indicate that
price of Gold Flake Kings (GFK) is likely hiked by ~15% (to Rs55/pack of ten). We
highlight that after the price hikes in Classic (premium) and Wills (mid-segment), price
increase in GFK is in line with our expectations. Through these price hikes, ITC is likely
creating ‘buffers’ before the budget, in our view. Retain estimates and ADD rating.
Signs of ‘predictable taxation regime’
Through the price increases in Classic (~10%), Wills (~15%) and GFK (likely ~15%) and in regularsize
filter segment (RSFT), ITC has likely created buffers for a potential ~10% excise increase in the
budget, in our view.
We address a key investor query, “What if there is a punitive excise increase for cigarettes in the
next budget?” Considering the addictive nature of the product and the associated consumer
behavior, the cigarette industry performs well (in volume terms) whenever there is predictability in
taxation (and resultant price increases which are shock-free from a consumer’s point of view).
A calibrated price increase of 3/4/5% over a period of time is significantly better than an
unplanned quantum increase post an increase in taxation (either at the state level or in the Central
budget). We note that the industry is relatively better-placed during times of higher predictability
as it could plan/phase the price increases/mix improvement etc. An analysis of historical trends
suggests that volume growth suffers when the industry implements steep price increases at one
go. The examples of 2001 and 2007 are worth highlighting (Exhibit 2) to see the impact of steep
price increases affecting demand in the near term. We highlight that there is a relevant second
variable also at play—per capita income growth.
In our view, excise or any form of taxation is an input cost for the cigarette industry (~60% of the
retail price of a cigarette stick is tax) and predictability in taxation increase helps the industry plan
for/hedge the impact of its input cost inflation.
Retain ADD; earnings visibility and potential for increase in payout are positives
We retain earnings estimates (EPS of Rs8 and Rs9.1 for FY2012E and FY2013E, respectively);
maintain ADD rating and target price of Rs230. Our underlying themes on ITC are intact,
(1) strong EPS CAGR of ~18% over FY2011-13E, (2) likely improvement in RoCE and (3) potential
for higher dividend payout. Key risks are (1) unexpected higher losses in other FMCG and (2) any
unprecedented increase in overall taxation impact.