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Mar 21, 2013, 02.38 PM IST | Source: CNBC-TV18

ITC's cigarette volumes may fall 3-4% in FY14: StanChart

In Budget 2013, government announced an increase in the excise duty on cigarettes. Till now four states have already increased value added tax (VAT) on cigarettes. Sanjay Singh of Standard Chartered Securities sees a 3-4 percent decline in cigarettes volume for ITC in FY14.

Sanjay Singh

Director, Standard Chartered Securities

Expertise : Equity - Fundamental

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In Budget 2013, the government announced an increase in the excise duty on cigarettes. Till now four states have already increased value added tax (VAT) on cigarettes.

VAT has increased by 450 basis points on year on year basis and cigarette major ITC will have to undertake 20 percent price hike to offset tax hikes, Sanjay Singh of Standard Chartered Securities said in an interview to CNBC-TV18.

He believes that absorption of this price hike will be a challenge for the consumers given the fact that there has not been two consecutive years of increase in prices.

"On the ground demand is very weak not only in tobacco but in overall consumption including staples. Hence, ITC will do a good double digit earnings growth may be about 13-15 percent. However, anything in the range of 18-20 percent looks impossible as of now," he added.

He sees a 3-4 percent decline in cigarettes volume for ITC in FY14.

Also read: Here's how you can reduce tax liability through indexation

Below is the verbatim transcript of his interview to CNBC-TV18

Q: A series of Value Added Tax (VAT) increases by practically all the leading states, is this something ITC can stomach?

A: At least the stock price shows that the market believes that this can be easily absorbed by ITC. However, it is all about expectations versus what is delivered. So, currently the street is expecting a 20 percent Cigarettes EBIT growth or a 20 percent EPS growth. This was what has been in the past four years.

This year the VAT increased by almost 450 bps on a weighted basis. This implies that we need a 20 percent plus price hike this year to manage profitability. Now, this will be the second consecutive year of 20 percent price hike. In the last 20 years of ITCs history which we are aware of, there has not been a single two consecutive years of even a 15 percent price hike. Now we are talking about a 20 percent price hike in an economy, which we are all aware of.

So, as of now everybody on the street believes that a 20 percent price hike will not disturb volumes too much. May be 1-2 percent drop and hence ITC will be able to do an earnings growth of 18-20 percent. However my sense is, given the economic environment we are currently in and lot of the price hikes are now 20 percent on a very high base so it means moving the ladder up quite significantly.

It will be a challenge for consumers to absorb this and we are very negative on demand. On the ground demand is very weak not only in tobacco but in overall consumption including staples. Hence, my sense is while ITC will do a good double digit earnings growth may be about 13-15 percent. However, anything in the range of 18-20 percent looks impossible as of now.

Q: So if we do have a downward risk to the price increase assumption and on the volume side as well, what will be the EPS you are working with for ITC?

A: Currently we are estimating a 20 percent price increase which should result in a 3-4 percent volume decline at least if not more. In a bear case it would be as high as 7-8 percent.

However, 4 percent is a more reasonable number and that should result in a 12-13 percent EPS growth. You have to also remember that the effective tax rate has gone up by 150 bps because of the surcharge increase of income tax. Hence, I am looking at a 13 percent EPS growth for FY14.

Q: How would the non-cigarette business perform? Will the P&L see pressure even from that side?

A: Non-cigarette FMCG actually looks better because company has been talking about reducing their losses and it has been coming off from sometime. However, I don’t think anybody expects a spectacular growth in profitability there. All depends also on some of the new launches which have been talked about like dairy etc which can add to the losses.

However, as of now that part looks quite good. So everybody is estimating including us that losses will come down. We will see some profits in FY14.

Q: So what would your price target be?

A: We are pretty much around the same levels. Around Rs 306-307 is our target price, so it is an inline call for us. We believe an absolute upside is pretty much difficult from here. Of course it might work as a portfolio call given the markets and the economy.

Q: What is the call on Hindustan Unilever ( HUL )?

A: HUL we have an inline call for sometime now. So, last eight-nine months has been an inline call for us largely because of demand situation and the royalty situation worsened it.

Given where HUL is currently today in terms of stock price, it looks better if economic situation improves a bit. Valuations are quite comfortable as of now. So, we are only concerned on the macro demand perspective otherwise HUL looks a little better at this point of time although we have an inline call on both.

Q: In FMCG what are the buys you are calling at all?

A: We are very worried on demand and given the valuations across the board it is very difficult to give a thumping absolute buy call from here on. Mostly we have an inline or underperformed calls.

The only buy calls, which we have is some of the midcaps like Britannia Industries. There we see some kind of margin expansion and a 15-20 percent absolute return is possible from a one year perspective. Dabur India looks comfortable in terms of valuations but overall the theme that we are riding on currently is that the demand is very poor on the ground.

Some of the stock prices and valuations are simply not showing it. As of now people believe that economy is resilient and will bounce back. Hence, it is just a quarter phenomena. We believe that it could be a little more pain here in times to come.

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