The new year has brought pain for investors of cigarette companies like ITC and Godfrey Phillips. After the government notified a new tax structure for cigarettes, tobacco, pan masala and related products, which will see their prices rise substantially and potentially hit sales hard, shares have continued to slip for a second straight session.
Several broking firms have downgraded their rating on ITC, the country’s largest cigarettes maker, on worries of sales taking a hit, the mix getting impacted, and concerns about illicit cigarettes rising again. The shares have slumped more than 13 per cent over two days, while rival Godfrey Phillips is down over 18 per cent.
From February 1, pan masala, cigarettes, tobacco and related products will attract a GST of 40 per cent, while biris will be taxed at 18 per cent. In addition to the GST, there will be a health and national security cess that will be levied on pan masala. Tobacco and related products will attract an additional excise duty.
The new tax structure will significantly raise prices, hurting demand, but there is also a worry that people may switch to illicit cigarettes as the price differential will now be substantial.
“ITC will need a price hike of at least 25 per cent at a portfolio level just to maintain the current net realisation per cigarette stick,” said analysts at Motilal Oswal Financial Services.
Such a sharp tax increase is unprecedented and surprising given the backdrop of stable taxes over the last few years, they said, pointing out that volumes in the illicit cigarette market had declined in the last 4-5 years, and ITC’s volumes had clocked a 5 per cent compounded annual growth in the last five years due to stable taxes.
Earnings pressure on cigarettes would take away the near-term catalysts like soft tobacco prices, recovery in the fast-moving consumer goods market and the paper industry, the analysts said.
The new excise duty structure is significantly higher than the current structure, contrary to the street expectation of a tax-neutral structure post transition to the new GST regime, said Mehul Desai of JM Financial Institutional Securities.
“A sharp duty hike will negatively impact volumes and meaningfully impact cigarette EBIT (earnings before interest and taxes), mix could see deterioration, and concerns on illicit cigarettes will also re-emerge,” said Desai.
Abneesh Roy, head of research at Nuvama Institutional Equities, pointed out that after such a sharp hike, volumes typically decrease 3-9 per cent; in the financial year 2011, volumes had decreased 3 per cent, following an 18 per cent price hike.
“A double-digit tax hike could push consumers towards smuggled cigarettes,” said Roy, who has cut the earnings (EBITDA) forecast for financial years 2027 and 2028 by 7 per cent.
Nitin Gupta of Emkay Global Financial Services also sees the new excise duties hurting near-to-medium term outlook and expects volume to decline 10 per cent this year and 2 per cent the next year as companies will raise prices in a staggered manner.
“Rise in excise duty on cigarettes, proposed to take effect from February 1, looks abnormally high, which can dent legal industry volume. We expect the companies to fully pass on the price hikes, which are 32 per cent across the portfolio. Such hikes will be put into effect in a staggered manner; we build in a 27 per cent price hike for FY2027 and 5 per cent for FY28,” said Gupta.
Cigarette companies are likely to see some tailwinds in the next financial year from lower leaf-tobacco prices. However, the sharp excise hike will impact margins. Gupta has slashed earnings estimates on ITC’s cigarette business by 25-35 per cent over the 2027-28 financial year.
