Mar 17, 2017 12:35 PM IST | Source: CNBC-TV18

GST structure may prove beneficial for ITC; overweight on stock: Edelweiss

Speaking to CNBC-TV18, Roy said the rate of cess decided upon tobacco products at Rs 4,170 per 1,000 sticks or 290 percent ad valorem and a cess on pan masala at 135 percent ad valorem is the highest cap proposed and that the actual rate of cess levied can be lower.

The final GST structure on tobacco products will prove positive for ITC as it will keep a check on illegal cigarettes that, otherwise, cornered a large chunk of the market, according to Abneesh Roy, Senior Vice President, Edelweiss Securities.

The GST Council on Thursday capped the cess on tobacco products at Rs 4,170 per 1,000 sticks or 290 percent and ad valorem on pan masala at 135 percent, over and above the GST rate.

Roy noted, the actual rate of cess levied could be lower as the proposed rate is the highest that can be levied.

He pointed out that a rational tax regime can reduce ITC’s valuation gap with companies like Hindustan Unilever (HUL), particularly if the tax incidence is revenue neutral.

With a target price of Rs 337, he maintained an overweight rating on the stock.

Below is the verbatim transcript of Abneesh Roy's interview to Latha Venkatesh, Sonia Shenoy and Anuj Singhal on CNBC-TV18.

Anuj: What is the call now on ITC looking at the technology structure considering that we have already seen quite a bit of rally in this stock?

A: Currently clarity on tax structure is still awaited. What has come out yesterday is the cap or the maximum. So obviously it will be mix of GST plus cess and cess is something which will compensate states for shortfall over the next five years. The cess can be lower than the cap proposed. So it is not that this cap comes from tomorrow or next year. This is something which is going to be determined based on the shortfall and for the next five years.

I think what Karnataka minister said yesterday and earlier comments by the finance ministry, those are also important in the absence of clarity on structure. They have said that the duty will be largely neutral for most of the sectors and what has happened in the last two budgets. So last two budgets, government also now understands that a rationale and a model tax policy is good for the government because then volume growth plus tax increase both are there and if there is a harsh tax then volumes decline.

For example, last six years volumes for cigarette industry declined by 15 percent and that is why last two budgets have corrected that and we have seen soft Budget. Based on the ministry comments and two soft budgets, it seems that it will be largely status quo but duty structure is something which remains unknown and if it is ad velorem then there could be cap on the margins but again we do not know whether it is a mix or how much is the ad velorem initially because this is over the next five years. So that is the clarity we still await.

Latha: You are buying that argument that the tax on the cigarettes will not be more than what it currently is, does that lend certainty to your valuation of ITC, what is your valuation of ITC, what is your rating, what is your price?

A: That is very good for ITC as a stock because this is a key overhang. We are positive on ITC, we have a target price of Rs 337 and we are overweight and this gives clarity because currently if you see the value added tax (VAT) rate is different in most states. So there is interest rate smuggling and there is no ease of business.

You cannot do Pan India marketing plans etc. Once GST comes, what will happen is entire country will have one rate, so much better planning. Secondly, the illegal cigarettes, which had already been impacted in the demonetisation drive they will also have much more surveillance in the GST regime because you will have much better compliance etc and illegal cigarettes in the country is quite big. So we see this advantage also lending to better valuation for ITC but of course the key unknown here is the tax structure but definitely GST as a policy is better than the current VAT structure which is different for every state. So we are positive on ITC.

Sonia: It still trades in a discount to many of its peers, right? You expect that bridge to be gapped and what would your EPS estimates be for next year?

A: Whenever we have seen rational taxation for cigarettes, we have seen HUL and ITC gap reduce. Currently again, HUL is trading at a big premium to ITC, this year we expect ITC to see EBIT growth of close to 15-16 percent provided in GST the tax structure is largely neutral versus current and our EPS estimate for ITC for FY18 is 10.3 and around 11.9 for FY19. So we are expecting around 15-16 percent compound annual growth rate (CAGR) in EPS and valuation comfort is definitely there. In the earlier time period we have seen ITC trade very close to HUL if the rationale tax policy is there. Currently there is again a very big gap between HUL and ITC. So definitely valuation discount is there currently in ITC.
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