ITC tanks 15% as analysts downgrade after GST Council hikes cess on cigarettes
Credit Suisse downgraded the stock to neutral from outperform and also slashed target price to Rs 310 from Rs 400 following cut in FY18-20 estimates by 10-12 percent.
ITC shares crashed 15 percent intraday Tuesday, the biggest intraday fall since 2012, as brokerage houses downgraded the stock after the Goods and Services Tax (GST) Council decided to increase the cess on cigarettes. However, the stock shot up 35 percent since the beginning of 2017 (till July 17).
Credit Suisse downgraded ITC to neutral from outperform and also slashed target price to Rs 310 from Rs 400 following cut in FY18-20 estimates by 10-12 percent.
It feels the stock will continue to face pressure on earnings progressively and the next trigger will be the tax hikes in the next year's annual Budget.
Rates have been changed for six categories of cigarettes on Monday. For non-filter cigarettes, not exceeding 65 mm, the rate has been increased to 5 percent plus Rs 2,076 per thousand sticks from existing rate of 5 percent plus Rs 1,591.
Similarly, for filter cigarettes exceeding 65 mm length but not more than 70 mm, rate has been increased by Rs 621 per thousand sticks and cigarettes exceeding 70 mm length but not more than 75 mm, rate has been increased by Rs 792 per thousand sticks.
New ad valorem rates on cigarettes above 75 mm stood at 36 percent.
The revised rates (effective July 18) will raise tax by 11-15 percent for all cigarette lengths other than the King Size (KSFT) segment wherein the tax increase is around 21 percent versus that in FY17.
"This implies that ITC will have to hike prices by 5-10 percent across its portfolio to maintain net realisation per stick, and will have to hike prices by an average of 8-9 percent to see a meaningful increase in net sales per stick, which is needed for driving earnings growth," Credit Suisse said.
CLSA also said this cess hike forced to downgrade the stock to sell from buy and cut target price to Rs 285 from Rs 417 on lower earnings as well as cut in cigarette business multiple."
It cut EPS estimates by 6-10 percent as it lowered cigarettes EBIT forecast to mid-single digits.
CLSA feels sharp rise in KSFT (84mm) may force ITC to explore longs (74mm) as an option to optimise tax and protect volumes but over time, and the company would need to raise prices by around 5 percent just to maintain net realisations.
Morgan Stanley, too, downgraded the stock to equal-weight from overweight and reduced target price to Rs 285 from Rs 395, saying it is a clear negative with obvious impact on volume growth and valuation multiples.
According to the research house, ITC will need 12-13 percent weighted average cigarette price hike hereon with around 20 percent price increase in KSFT segment to offset tax increase.
Given that ITC has already taken around 4 percent price hike versus average of FY17, it expects an incremental 8-9 percent pricing action over the next few days.
Morgan Stanley expects 3 percent volume decline in FY18 versus earlier estimate of 5 percent growth and expects 6 percent cigarette business EBIT growth versus 20 percent earlier.
The government on Monday said that it miscalculated the tax on cigarettes. Its method of calibrating the cess did not take into consideration the cascading of taxes. This led to a lower tax incidence under GST. According to the government, this is 'unacceptable' in case of demerit goods like cigarettes.
In May, the Council headed by Finance Minister Arun Jaitley had fixed the rate for the demerit goods — cigarettes — in the highest tax slab of 28 percent and a cess over and above the tax rate, which would ultimately go to the compensation kitty of the states.
The compensation cess had two components — an ad valorem of 5 percent and an increasing numerical amount and on each category of filter and non-filter cigarette.
While the 28 percent tax and an ad valorem at 5 percent will remain, the numerical value of cess on cigarettes will be increased from midnight, Finance Minister Arun Jaitley said adding that the total revenue impact of this is expected to be Rs 5,000 crore.
“Now this rate (fixed by the fitment committee) when translated as a part of cost of the cigarette itself, indicated that the impact of the cascading effect has not been factored in. Therefore, it was resulting in a windfall profit for cigarette companies,” Jaitley said after the conclusion of the 19th GST Council meeting.
Meanwhile, ICICI Securities downgraded VST Industries to hold with a target price of Rs 3,430 as it believes that with around 16 percent increase in tax incidence compared to pre-GST level, cigarette volumes would continue to remain under pressure.
"With increased tax incidence, PAT estimates get revised downwards by 9.2 percent and 13.3 percent for FY18 and FY19, respectively," it said.At 09:36 hours IST, ITC was quoting at Rs 285.95, down 12.22 percent while VST Industries was down 3.5 percent at Rs 3,435 and Godfrey Phillips India down 4.98 percent at Rs 1,166.35 amid high volumes on the BSE.