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Pricing power is the key
The union budget added ad-valorem component to the current specific excise
duties on cigarettes, translating into a weighted average hike of ~15% (quantum,
broadly in-line with market expectations). The imposition of ad-valorem may raise
long term concerns but we highlight that since the imposition of state VAT in 2007,
ITC’s cigarette Ebit has grown at 16% Cagr, clearly highlighting its pricing power.
There could also be a volume tailwind from the revised excise duty slab for sub-
65mm, which would allow the organised industry to grab shares from illicit market.
Excise duty structure becomes hybrid with effective hike at ~15%...
q The budget, while retained existing specific excise rates which are based on the
length of cigarette (slight change in classification for sub 70-mm, though)…
q … added 5% ad-valorem duty on consumer price (MRP) to current slabs.
q We estimate weighted average excise duty hike at ~15% for ITC (~17.5%
including VAT impact) which meets the upper-end of the market expectations.
… and a new size comes to life at sub-65mm
q The budget also created a new slab of sub-65mm attracting an excise duty of
Re0.67/stick, with no ad-valorem component.
q In the earlier regime, the excise slabs were sub-60mm and 60-70mm where the
duties were at Re0.67/stick and Re0.97/stick respectively.
q Currently, legitimate industry derives insignificant proportion from sub-60mm.
The hybrid system raises the proportion of variable taxes…
q The move to ad-valorem is not a sea change as ITC, even today, pays 30% of total
taxes in variable form due to VAT levied by different states (provinces) in India.
q The proportion of variable taxes would rise to 40% under the new regime.
q While risk persists on increasing proportion of variable excise in future, requiring
higher price hikes, we do not see it as a big threat given ITC’s leadership.
q This is also evident from the fact that after the levy of state VAT in 2007, ITC has
been able to grow its cigarette Ebit at a 16% Cagr in the last five years.
… while new slab could drive volumes, particularly from illicit market
q We expect ITC (and industry) to launch brands at sub-64mm given the economics.
q Interactions with an industry contact indicate that ~8% of the market is currently
occupied by illicit cigarettes which organised players could now target.
Remain confident of ITC’s pricing power; no downside to estimates
q Industry checks indicate that the players may take time in rolling out revised
prices due to the change in methodology and complexity in SKU structure.
q Our calculations indicate that ITC needs to take up prices by ~8% to neutralise the
impact of excise duty hikes.
q We would however expect ITC to take up prices by around ~15% and grow Ebit by
14-15%; we do not see any downside risk to our current estimates, therefore.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Pricing power is the key
The union budget added ad-valorem component to the current specific excise
duties on cigarettes, translating into a weighted average hike of ~15% (quantum,
broadly in-line with market expectations). The imposition of ad-valorem may raise
long term concerns but we highlight that since the imposition of state VAT in 2007,
ITC’s cigarette Ebit has grown at 16% Cagr, clearly highlighting its pricing power.
There could also be a volume tailwind from the revised excise duty slab for sub-
65mm, which would allow the organised industry to grab shares from illicit market.
Excise duty structure becomes hybrid with effective hike at ~15%...
q The budget, while retained existing specific excise rates which are based on the
length of cigarette (slight change in classification for sub 70-mm, though)…
q … added 5% ad-valorem duty on consumer price (MRP) to current slabs.
q We estimate weighted average excise duty hike at ~15% for ITC (~17.5%
including VAT impact) which meets the upper-end of the market expectations.
… and a new size comes to life at sub-65mm
q The budget also created a new slab of sub-65mm attracting an excise duty of
Re0.67/stick, with no ad-valorem component.
q In the earlier regime, the excise slabs were sub-60mm and 60-70mm where the
duties were at Re0.67/stick and Re0.97/stick respectively.
q Currently, legitimate industry derives insignificant proportion from sub-60mm.
The hybrid system raises the proportion of variable taxes…
q The move to ad-valorem is not a sea change as ITC, even today, pays 30% of total
taxes in variable form due to VAT levied by different states (provinces) in India.
q The proportion of variable taxes would rise to 40% under the new regime.
q While risk persists on increasing proportion of variable excise in future, requiring
higher price hikes, we do not see it as a big threat given ITC’s leadership.
q This is also evident from the fact that after the levy of state VAT in 2007, ITC has
been able to grow its cigarette Ebit at a 16% Cagr in the last five years.
… while new slab could drive volumes, particularly from illicit market
q We expect ITC (and industry) to launch brands at sub-64mm given the economics.
q Interactions with an industry contact indicate that ~8% of the market is currently
occupied by illicit cigarettes which organised players could now target.
Remain confident of ITC’s pricing power; no downside to estimates
q Industry checks indicate that the players may take time in rolling out revised
prices due to the change in methodology and complexity in SKU structure.
q Our calculations indicate that ITC needs to take up prices by ~8% to neutralise the
impact of excise duty hikes.
q We would however expect ITC to take up prices by around ~15% and grow Ebit by
14-15%; we do not see any downside risk to our current estimates, therefore.
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