May 09, 2012, 03.40 PM IST | Source: CNBC-TV18

'Removal of ad valorem tax a long-term positive for ITC'

Sanjay Singh, analyst at Standard Chartered says, removal of ad valorem tax is a long-term positive for ITC.

Sanjay Singh

Director, Standard Chartered Securities

Expertise : Equity - Fundamental

More about the Expert...

The ad valorem taxation, 5% of MRP, which was imposed on ITC in this year’s Budget in March, has been withdrawn. It has been replaced by a specific duty increase of 22%.

In an interview to CNBC-TV18, Sanjay Singh, analyst at Standard Chartered says, removal of ad valorem tax is a long-term positive for ITC. “Ad valorem was a very negative taxation for the cigarette industry because every time you raise prices, your taxes increase and hence your ability to appropriate full price hikes was away. Now that makes margin expansion difficult in the long run. ITC has been able to expand its cigarette EBIT growth in mid teens consistently on the back of margin expansion. With ad valorem taxes, that would have been difficult in the long run. But now with ad valorem taxes going away, this becomes again a possibility. Hence, it’s a long-term positive,” he expalains.

Below is the edited transcript of his interview with CNBC-TV18's Udayan Mukherjee and Mitali Mukherjee. Also watch the accompanying video.

Q: What is your view on ITC?

A: I think there was some confusion yesterday, when stock fell down by almost 3-4%. The ad valorem taxation, basically 5% of MRP, which was imposed on ITC in this year’s Budget in March, has been withdrawn. It has been replaced by a specific duty increase of 22% for ITC. Now, if you convert the 5% ad valorem, it is working to around 18%. So, basically an 18% excise increase has been changed to 22%. So, at the margin, the excise increase looks a little higher.

Ad valorem was a very negative taxation for the cigarette industry because every time you raise prices, your taxes increase and hence your ability to appropriate full price hikes was away. Now that makes margin expansion difficult in the long run. ITC has been able to expand its cigarette EBIT growth in mid teens consistently on the back of margin expansion. With ad valorem taxes, that would have been difficult in the long run. But now with ad valorem taxes going away, this becomes again a possibility. Hence, it’s a long-term positive.

Excise rates change from 18% to 22% in a tad negative. But I don’t see any impact on EPS or earnings for ITC. The price increases have to be a little higher and hence the volume impact is a little higher, but there is no impact on earnings for FY13. So, I see it as a positive. At any weakness, I would buy.

Q: The suggestion seems to be that about 5% price increase will mitigate any potential damage. Do you agree with that?

A: Earlier, the price increase was supposed to be 15% for FY13 to ensure a mid teens cigarette EBIT growth. Now the price hike has to be 20% to ensure a mid teens cigarette EBIT growth. Company has already done a price hike of around 12% or thereabouts. So, another round of maybe 6-8% is what they require to ensure a mid teen EBIT growth for cigarettes this year.

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