Budget Impact: Smokers to pay more

Smokers to pay more:

Key points 

• Excise duty increased by 18%: The Government of India has implemented a weighted average excise duty hike of 18% on cigarettes in the Union Budget 2013-14 (the basic excise duty on cigarettes has been increased by about 21%). This is the second consecutive year of a significant increase in the excise duty on cigarettes in India. We were expecting the excise duty to increase by only 6-8% in view of the fact that the excise duty on cigarettes had been increased significantly in the last year's Union Budget. 
• Price increase of ~14% to neutralise the impact: ITC enjoys strong pricing power in the Indian market. We believe it will have to hike the prices of its cigarettes by around 14% to maintain the cigarette business' earnings before interest and tax (EBIT) margin in the range of 31-32%. However, the prices would be increased largely in a phased manner, as the company would be closely monitoring any significant increase in the value added tax (VAT) rates of the key states. Also, the company had increased the prices of its cigarettes significantly in the quarters following the sharp increase in the excise duty in the Union budget 2012-13 which had taken some time to get absorbed in the market.
• Volume growth to remain subdued in FY2014: The price increase of around 15% will have an impact on the sales volumes of the company. We expect the sales volume growth to remain subdued in FY2014, as the cigarette smokers have to pay a significantly high price for a stick of cigarette. We have revised downwards our volume growth assumption to 1% (fro mid-single digit earlier) for FY2014. 
• National launch of 64mm cigarettes shortly: In the recent budget the government has spared cigarettes of length not exceeding 65mm from any excise duty hike. ITC's launch of 64mm cigarette is gaining good response in 17-18 domestic markets. We expect the national launch of 64mm in the coming months.
• Valuation and outlook: This is the second consecutive year of a significant increase in the excise duty on cigarettes. In view of the company's strong pricing power and the price inelastic nature of the product category, we expect ITC to take price increases in its cigarette portfolio in the coming quarters to safeguard its margins. We need to keenly monitor the impact of the price increase on the sales volume of the cigarette business and the quantum of increase in the VAT rate in the key states. We broadly maintain our earnings estimates for FY2014 and FY2015. At the current market price the stock trades at 30.4x its FY2013E earnings per share (EPS) of Rs9.6, 25.3x its FY2014E EPS of Rs11.5 and 21.3x its FY2015E EPS of Rs13.6. We maintain our Buy recommendation on the stock with a price target of Rs340.
  
  
  RAZI ANWAR
  PGDM 2nd year