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ITC
ITC pricing in a nasty budget?
Despite reporting a 19% EBITDA growth in 3QFY11, and having a very defensive
business with strong pricing power, ITC has underperformed the market by 3%,
and HUVR by 10%. We reckon, this is largely pricing in a adverse budget. We
analyse the possibilities and implications. We reiterate Buy.
ITC's underperformance reflects the worst case fears
! We believe the biggest fear in the Budget 2011 with regard to cigarette taxation is the
possibility of moving the basis of levy of excise duty on cigarettes from a length-based
specific excise duty regime to a price-based ad volerem duty structure. Currently, excise duty
is #55% of selling price and VAT is 15% of selling price. Implications on ITC, if the above
change happens would be: 1) the biggest positive impact would be the ability of ITC and the
industry to price cigarettes competitively at price points even below Re1 to drive volumes and
migration from bidis. Under the current excise regime, the minimum per stick excise duty is
0.67 paise, which makes it impossible for the industry to price cigarette below Re1.5/stick. 2)
Negative impact would be that under an ad valorem structure, excise incidence would rise
proportionately for every price hike ITC initiates. Currently, since the excise incidence is
based on volumes, the levy is the same irrespective of the cigarette price.
Possibility of ad valorem duty structure on cigarettes looks remote
! We believe the possibility of an ad valorem structure is remote as: 1) the current regime has
worked seamlessly for the government with no litigation. Prior to 1984, when India had an ad
valorem excise duty structure, there were a host of litigation and allegations of excise evasion
by the industry due to valuation disputes. 2) An ad valorem levy, would structurally improve
the competitiveness of cigarettes as compared to bidis. Given the strength of the "bidi" lobby
and the political implications, we again see the possibility of change in structure difficult.
However, if the structure is changed, we believe it would be negative for ITC given its strength
in the premium segments, where incremental price hikes going forward would attract higher
excise incidence, hence would impact volumes sharper than in the past.
Current underperformance, offers a good buying opportunity
! ITC's business has very strong pricing power, and premium segments demand for cigarettes
is largely inelastic to business cycles. In an inflationary environment, where margin risk is
higher in other FMCG companies, we believe the risk to ITC's earnings is limited, as
cigarettes account for 83% of ITC's EBIT in FY11. Besides, ITC's non-cigarette business have
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
ITC
ITC pricing in a nasty budget?
Despite reporting a 19% EBITDA growth in 3QFY11, and having a very defensive
business with strong pricing power, ITC has underperformed the market by 3%,
and HUVR by 10%. We reckon, this is largely pricing in a adverse budget. We
analyse the possibilities and implications. We reiterate Buy.
ITC's underperformance reflects the worst case fears
! We believe the biggest fear in the Budget 2011 with regard to cigarette taxation is the
possibility of moving the basis of levy of excise duty on cigarettes from a length-based
specific excise duty regime to a price-based ad volerem duty structure. Currently, excise duty
is #55% of selling price and VAT is 15% of selling price. Implications on ITC, if the above
change happens would be: 1) the biggest positive impact would be the ability of ITC and the
industry to price cigarettes competitively at price points even below Re1 to drive volumes and
migration from bidis. Under the current excise regime, the minimum per stick excise duty is
0.67 paise, which makes it impossible for the industry to price cigarette below Re1.5/stick. 2)
Negative impact would be that under an ad valorem structure, excise incidence would rise
proportionately for every price hike ITC initiates. Currently, since the excise incidence is
based on volumes, the levy is the same irrespective of the cigarette price.
Possibility of ad valorem duty structure on cigarettes looks remote
! We believe the possibility of an ad valorem structure is remote as: 1) the current regime has
worked seamlessly for the government with no litigation. Prior to 1984, when India had an ad
valorem excise duty structure, there were a host of litigation and allegations of excise evasion
by the industry due to valuation disputes. 2) An ad valorem levy, would structurally improve
the competitiveness of cigarettes as compared to bidis. Given the strength of the "bidi" lobby
and the political implications, we again see the possibility of change in structure difficult.
However, if the structure is changed, we believe it would be negative for ITC given its strength
in the premium segments, where incremental price hikes going forward would attract higher
excise incidence, hence would impact volumes sharper than in the past.
Current underperformance, offers a good buying opportunity
! ITC's business has very strong pricing power, and premium segments demand for cigarettes
is largely inelastic to business cycles. In an inflationary environment, where margin risk is
higher in other FMCG companies, we believe the risk to ITC's earnings is limited, as
cigarettes account for 83% of ITC's EBIT in FY11. Besides, ITC's non-cigarette business have
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