ITC: The Budget effect

Last Updated: Tue, Mar 06, 2012 08:07 hrs
ITC shuts cigarette units on uncertainty over warnings

Around this time every year, shares of ITC come under pressure, on the buzz that government levies on cigarettes could increase. It's almost a routine exercise for FMCG analysts to come up with projections on how such an increase would impact the demand for cigarettes. This year is no different, with the market building in a 10-15 per cent increase in excise. But, analysts are upbeat on the stock, as data from the last 10 years suggest that investors who bought ITC shares before or during the presentation of the Union Budget earned positive returns over the subsequent months.

JP Morgan, which has done the number crunching, says: "On a three-month return basis, the stock delivered positive returns in nine of the past 10 instances after the Budget. On a one-month basis, positive returns were generated in seven of the 10 instances."

What if excise increases are more than 20 per cent? Analysts don't seem unduly perturbed. Even during the years when tax increases were aggressive, the stock recovered in subsequent months, as ITC is known for its aggressive pricing strategy. As seen in recent times, the company undertakes price increases mostly ahead of the Budget so that the increase neutralises the impact. As a result, margins keep improving on a consistent basis. In years of aggressive tax rises (FY08/09/11), cigarette Ebit grew 15-17 per cent.

While central excise is a risk, in recent times, states, too, have been increasing value-added tax (VAT) on cigarettes. This trend was started by Maharashtra in 2010, when it increased VAT on cigarettes from 12.5 per cent to 20 per cent. At present, VAT ranges between 12.5-40 per cent across states. Over the last two years, ITC's average VAT for cigarettes increased 570 basis points, from 12.5 per cent to 18.2 per cent, on sharp and differential increase in VAT by states. However, this year, IDFC Securities expects the company's average VAT for FY13 to increase 200 basis points to 20 per cent, which would require a 2-2.5 per cent price increase to neutralise.

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