ITC : Filtering growth

Higher prices could lead to lower volumes.

India’s leading cigarette manufacturer ITC, which commands a market share of 74 per cent, will need to cough up about 17 per cent more by way of excise duties from FY09.

That’s a consequence of the hike in excise duties for plains, where the duty is up from 56 paise to Rs 132 paise per stick and for micros where it has gone up from 17 paise to 82 paise per stick. Micros and plains together account for about 20 per cent of cigarette volumes, but contribute less than 10 per cent of profits. It’s not clear how exactly the higher duties will be passed on. The Rs 12,369 crore ITC could choose to spread the price hike across the entire portfolio rather than raise prices of just non-filter brands. Either way, there could be some impact on volumes, which are now estimated to grow by about 1 per cent in FY09. Nonetheless, ITC has the advantage of a big portfolio and, therefore, an option to cross-subsidise non-filters. A larger proportion of sales of higher-end products will boost margins and over time, it may choose to exit plains and introduce regular filter cigarettes at lower price points because the hike on non-filters means the migration from bidis to cigarettes will be slower. Currently, plains cost Rs 1.5-1.75 per stick while micros are priced at Rs 2-2.25 per stick. ITC has gradually been foraying into new areas; it now a presence in hotels, paper, foods and lifestyle products. However, more than 75 per cent of its revenues accrue from cigarettes.

Over the last 12 months, the stock has underperformed the Sensex by 12 per cent primarily because of concerns about VAT, which was imposed at 12.5 per cent and threatened to dampen volumes. Between FY05-07, the stock has traded at an average forward multiple of 24.

The stock, which at Rs 193, trades at 19 times FY09 estimated earnings, is not cheap, given that earnings are expected to grow at around 20 per cent over the next couple of years. However, it could be a good defensive play.