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India Equity Research Reports, IPO and Stock News
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A sharp mid-term tax hike and another increase in
excise and VAT rates in FY13 budget could moderate
earnings growth and, more importantly, drag down the
significant valuation premium that ITC currently enjoys.
Constant inching up of VAT rates and no consensus
among states are concerns the street is not factoring in.
Market share loss to VST and GPI and increasing gap
between bidi and cigarette prices has lowered ITC’s
‘bandwidth’ to increase prices.
We believe at current valuations all positives are pricedin. Maintain IN-LINE with PT of Rs210
Mid-year excise hikes? Media reports (source: CNBC
TV18) suggest that the government is considering
increasing excise on cigarettes by 20-30% by the end of 2Q
FY12. If it happens, ITC will need to hike prices by at least
15-22% to maintain low-teens PBIT growth. We believe,
even if excise is not increased mid-year, expectations of
punitive taxation in the next budget will keep the stock under
pressure in the near term.
Uncertainty over VAT is a bigger risk. Even three years
after introducing VAT for cigarettes, there is no consensus
on VAT – they keep inching up. Initially, VAT was expected
to remain at 12.5%, but over the past three years it has
risen to 20% in many states, which most believed to be the
ceiling. However, in FY12 the 20% ‘ceiling’ was not just
breached but raised to 40%. Recent VAT hike in Tamil
Nadu raises risk of increases in other southern states in
FY13. The ad valorem nature of VAT reduces ITC’s margin
leverage and makes it relatively difficult to manage.
Affordability & competition impacting volume. Per stick
price (for ITC) has increased at a CAGR of 15.4% over
FY07-11 – higher than average inflation. This has reduced
affordability and resulted in down trading – we note that
VST volume was up 9%, GPI volume was flat vis-à-vis 3%
decline for ITC in FY11. Increasing gap between bidi &
cigarette prices has resulted in down trading among dual
smokers (15% of smokers). Our channel checks suggest
volume pressure in regular filter is higher – this has reduced
ITC’s bandwidth to raise prices.
Valuation retracement? Forward earnings could correct by
~10% on sharp mid-term excise hike, VAT rate increase in
FY13 and excise increase in the next budget. Muted
earnings growth, sharp decline in cigarette volumes &
taxation uncertainty can lead to some retracement of the
valuation premium gained by ITC over the past 12-months
‘Bandwidth’ to raise prices has come down
In the past few years (FY07-11), ITC’s volumes have remained flat despite 15% CAGR in prices.
The street has interpreted this as increased inelasticity and improved affordability for cigarettes.
However, we note that consumers were able to absorb sharp price increases in these years
(FY07-11) because of the ‘bandwidth’ created in the previous years – in the period FY03-07
prices increased at a CAGR of mere 3.4%. We believe ITC’s bandwidth to raise prices has
reduced or capacity of consumers to absorb prices has come down on the back of i) sharp price
increases in the past few years, ii) widening gap between cigarettes and bidi prices and iii) lower
priced offerings from players like VST and other regional players. Regional players like VST
Industries (operating in the value-for-money segment) have posted strong volume growth of 9%
as compared to 3% decline for ITC. Illegal cigarette market is also increasingly becoming a
concern for the company − as per ITC’s estimates illegal cigarette sales has grown at 58% over
the period 2004-09 and now constitutes ~16% of the total industry size.
Valuation retracement a possibility
ITC currently trades at one year forward P/E of 25.5x – 22% premium to 6-year median P/E of
21x. Currently, premium to BSE Sensex stands at 86% vis-à-vis 40% historically. The re-rating
was mainly on the back of improving RoE, higher dividend payout and strong volume resilience to
sharp price hikes necessitated because of high taxation increases. With continued uncertainty on
VAT, possibility of higher excise hikes, declining volumes and moderate earnings growth, we
believe there is a possibility of some retracement in the valuation premium gained by ITC over
the past 12-months. We value ITC at a forward P/E of 23x (10% premium to its six-year median)
with a price target of Rs210.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
A sharp mid-term tax hike and another increase in
excise and VAT rates in FY13 budget could moderate
earnings growth and, more importantly, drag down the
significant valuation premium that ITC currently enjoys.
Constant inching up of VAT rates and no consensus
among states are concerns the street is not factoring in.
Market share loss to VST and GPI and increasing gap
between bidi and cigarette prices has lowered ITC’s
‘bandwidth’ to increase prices.
We believe at current valuations all positives are pricedin. Maintain IN-LINE with PT of Rs210
Mid-year excise hikes? Media reports (source: CNBC
TV18) suggest that the government is considering
increasing excise on cigarettes by 20-30% by the end of 2Q
FY12. If it happens, ITC will need to hike prices by at least
15-22% to maintain low-teens PBIT growth. We believe,
even if excise is not increased mid-year, expectations of
punitive taxation in the next budget will keep the stock under
pressure in the near term.
Uncertainty over VAT is a bigger risk. Even three years
after introducing VAT for cigarettes, there is no consensus
on VAT – they keep inching up. Initially, VAT was expected
to remain at 12.5%, but over the past three years it has
risen to 20% in many states, which most believed to be the
ceiling. However, in FY12 the 20% ‘ceiling’ was not just
breached but raised to 40%. Recent VAT hike in Tamil
Nadu raises risk of increases in other southern states in
FY13. The ad valorem nature of VAT reduces ITC’s margin
leverage and makes it relatively difficult to manage.
Affordability & competition impacting volume. Per stick
price (for ITC) has increased at a CAGR of 15.4% over
FY07-11 – higher than average inflation. This has reduced
affordability and resulted in down trading – we note that
VST volume was up 9%, GPI volume was flat vis-à-vis 3%
decline for ITC in FY11. Increasing gap between bidi &
cigarette prices has resulted in down trading among dual
smokers (15% of smokers). Our channel checks suggest
volume pressure in regular filter is higher – this has reduced
ITC’s bandwidth to raise prices.
Valuation retracement? Forward earnings could correct by
~10% on sharp mid-term excise hike, VAT rate increase in
FY13 and excise increase in the next budget. Muted
earnings growth, sharp decline in cigarette volumes &
taxation uncertainty can lead to some retracement of the
valuation premium gained by ITC over the past 12-months
‘Bandwidth’ to raise prices has come down
In the past few years (FY07-11), ITC’s volumes have remained flat despite 15% CAGR in prices.
The street has interpreted this as increased inelasticity and improved affordability for cigarettes.
However, we note that consumers were able to absorb sharp price increases in these years
(FY07-11) because of the ‘bandwidth’ created in the previous years – in the period FY03-07
prices increased at a CAGR of mere 3.4%. We believe ITC’s bandwidth to raise prices has
reduced or capacity of consumers to absorb prices has come down on the back of i) sharp price
increases in the past few years, ii) widening gap between cigarettes and bidi prices and iii) lower
priced offerings from players like VST and other regional players. Regional players like VST
Industries (operating in the value-for-money segment) have posted strong volume growth of 9%
as compared to 3% decline for ITC. Illegal cigarette market is also increasingly becoming a
concern for the company − as per ITC’s estimates illegal cigarette sales has grown at 58% over
the period 2004-09 and now constitutes ~16% of the total industry size.
Valuation retracement a possibility
ITC currently trades at one year forward P/E of 25.5x – 22% premium to 6-year median P/E of
21x. Currently, premium to BSE Sensex stands at 86% vis-à-vis 40% historically. The re-rating
was mainly on the back of improving RoE, higher dividend payout and strong volume resilience to
sharp price hikes necessitated because of high taxation increases. With continued uncertainty on
VAT, possibility of higher excise hikes, declining volumes and moderate earnings growth, we
believe there is a possibility of some retracement in the valuation premium gained by ITC over
the past 12-months. We value ITC at a forward P/E of 23x (10% premium to its six-year median)
with a price target of Rs210.
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