News Analysis

ITC smokes away its gains

Parvatha Vardhini C BL Research Bureau | Updated on January 11, 2018

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The ITC stock has dropped about 12 per cent in trading today, following the government’s move to hike cess on cigarettes under the GST regime. With the earlier GST rates making cigarettes cheaper, the stock had gained about 25 per cent to touch its one year high of Rs 353 on July 3, since the announcement of the GST rates in the third week of May. ITC is the market leader in the legal cigarette industry and derives about 80 per cent of its pre-tax profits from cigarettes.

What has changed?

Cigarettes continue to be taxed at the highest GST rate of 28 per cent. The ad valorem compensation cess of 5 per cent on most filter (up to 75 mm) and non-filter cigarettes (up to 70 mm) too applies. What has changed now are two things: one, the cess has been pushed up by ₹485-792 per 1,000 sticks across the filter and non-filter categories. For the other cigarettes category, the ad valorem cess has been increased by 31 per cent now to a total of 36 per cent.

These changes have been brought about because, according to the government, its earlier method of fixing the cess did not take into consideration the fact that the cascading effect of taxes would not be present under GST. Hence, this led to an unintended lower tax incidence for cigarettes under GST vis-à-vis what was prevalent earlier. The latest move to correct the anomaly keeps the blended tax incidence across categories same as pre-GST levels. But it increases taxes on cigarettes from the pre-GST levels in certain categories. Take the 65-70mm category which brings about half the cigarette revenues for the company. Here, the tax incidence moves up by about 6 per cent compared with the pre-GST levels after the latest changes.

A report put out by Morgan Stanley indicates that ITC will need 12-13 per cent weighted average cigarette price hike here on to offset the tax increases. CLSA expects a minimum 5 per cent price hike by ITC in order to maintain realisations. This implies that the company is in a tight spot now – if it increases prices, volumes may take a hit in the near to medium term ; if it chooses to absorb the price hikes, margins may take a hit.

Published on July 18, 2017

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