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ITC (ITC)
Consumer products
The difference (this time) lies in predictability. Considering the addictive nature of
cigarettes and the associated consumer behavior, predictability in taxation (and hence
calibrated price increases) is the key for industry volume performance. The current statelevel
levies including VAT for ITC is ~18%, in our view; which could potentially increase
to ~21% in the scenario of all states (the ones which are below 20% at present)
increasing the VAT rate to 20%. However, we agree with investors that absolute
returns in the ITC stock in the near term could potentially be constrained because of the
taxation overhang. We also present takeaways from discussions with an industry expert
as to the challenges faced by Marlboro in ramping up its India presence. Retain ADD.
Predictable taxation regime + calibrated price hikes = not so uncertain times for ITC
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 3)
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.
VAT impact may not be materially worrisome in short term
The current weighted average VAT incidence for ITC is ~18%, in our view. This will likely increase
to ~21% in the scenario of all states increasing the VAT rate to 20% (the ones which are below
20% at present—key ones being Karnataka, Kerala and Tamil Nadu). We also note that VAT rates
in a couple of states are higher than 20% (Gujarat 25% and Rajasthan 40%—both accounting for
~3% each of ITC’s cigarette sales, in our view). Exhibit 1 gives the status of state-wise VAT rates
and the likely state-level cigarette sales salience (our estimates).
Takeaways from discussions with an industry expert
Philip Morris India is likely to pull out the Marlboro Compact (Rs3.5/stick) from the market
as the test launch has likely not met its expectations. We were always bullish on ITC’s
prospects to tackle competition as elaborated in our note dated October 29, 2010.
Our earlier comments were “While our channel checks suggests muted consumer
acceptance of Marlboro Compact (despite the brand being well known in big cities), we
keenly watch the market performance of it in the RSFT segment (smaller cigarette, 69
mm). In our view, the cigarette market scenario still favors ITC as, (1) Godfrey Philips (GPI)
and Philip Morris need to ensure that Marlboro Compact (owned by Philip Morris directly)
do not cannibalize GPI's sales, and (2) relatively limited geographical distribution reach of
GPI versus market leader ITC.”
One of the major reasons for limited consumer acceptance of Marlboro in India is
blend/flavor. According to the expert, most of the ITC’s products are the ‘Virginia’ blend
whereas Marlboro is the ‘American’ blend.
The push-based sales at the retail outlet level have been difficult for Marlboro to
implement considering the market dominance of ITC (~75-80% market share).
Cigarette industry is witnessing consumer uptrading—King Size Filter (KSFT) segment (of
84 mm or higher and Rs5 retail price or higher) growth (>10%) is substantially higher
than overall cigarette industry growth. The KSFT segment accounts for ~15% of ITC’s
portfolio and it has superior margins, in our view.
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 TP 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, (2) any
unprecedented increase in overall taxation impact.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
ITC (ITC)
Consumer products
The difference (this time) lies in predictability. Considering the addictive nature of
cigarettes and the associated consumer behavior, predictability in taxation (and hence
calibrated price increases) is the key for industry volume performance. The current statelevel
levies including VAT for ITC is ~18%, in our view; which could potentially increase
to ~21% in the scenario of all states (the ones which are below 20% at present)
increasing the VAT rate to 20%. However, we agree with investors that absolute
returns in the ITC stock in the near term could potentially be constrained because of the
taxation overhang. We also present takeaways from discussions with an industry expert
as to the challenges faced by Marlboro in ramping up its India presence. Retain ADD.
Predictable taxation regime + calibrated price hikes = not so uncertain times for ITC
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 3)
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.
VAT impact may not be materially worrisome in short term
The current weighted average VAT incidence for ITC is ~18%, in our view. This will likely increase
to ~21% in the scenario of all states increasing the VAT rate to 20% (the ones which are below
20% at present—key ones being Karnataka, Kerala and Tamil Nadu). We also note that VAT rates
in a couple of states are higher than 20% (Gujarat 25% and Rajasthan 40%—both accounting for
~3% each of ITC’s cigarette sales, in our view). Exhibit 1 gives the status of state-wise VAT rates
and the likely state-level cigarette sales salience (our estimates).
Takeaways from discussions with an industry expert
Philip Morris India is likely to pull out the Marlboro Compact (Rs3.5/stick) from the market
as the test launch has likely not met its expectations. We were always bullish on ITC’s
prospects to tackle competition as elaborated in our note dated October 29, 2010.
Our earlier comments were “While our channel checks suggests muted consumer
acceptance of Marlboro Compact (despite the brand being well known in big cities), we
keenly watch the market performance of it in the RSFT segment (smaller cigarette, 69
mm). In our view, the cigarette market scenario still favors ITC as, (1) Godfrey Philips (GPI)
and Philip Morris need to ensure that Marlboro Compact (owned by Philip Morris directly)
do not cannibalize GPI's sales, and (2) relatively limited geographical distribution reach of
GPI versus market leader ITC.”
One of the major reasons for limited consumer acceptance of Marlboro in India is
blend/flavor. According to the expert, most of the ITC’s products are the ‘Virginia’ blend
whereas Marlboro is the ‘American’ blend.
The push-based sales at the retail outlet level have been difficult for Marlboro to
implement considering the market dominance of ITC (~75-80% market share).
Cigarette industry is witnessing consumer uptrading—King Size Filter (KSFT) segment (of
84 mm or higher and Rs5 retail price or higher) growth (>10%) is substantially higher
than overall cigarette industry growth. The KSFT segment accounts for ~15% of ITC’s
portfolio and it has superior margins, in our view.
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 TP 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, (2) any
unprecedented increase in overall taxation impact.
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