Buy ITC; target of Rs 240: Prabhudas Lilladher

“ITC, after the announcements of key state budgets, ITC has seen a ~80bps increase in its weighted average VAT rate, as per our estimates. While Karnataka and Kerala have increased Cig VAT to 17% and 15%, respectively, other key states viz. TN, Maharashtra, West Bengal and AP have left the rate unchanged. Blended VAT for ITC now stands at 19.3% v/s 18.5% earlier, as per our workings. We see reluctance on the part of majority of the states to hike VAT above 20%. Coupled with this VAT increase, government recently changed the excise duty structure of Cig, culminating into 15% excise duty hike for ITC. It has also created a new slab of sub- 65mm length Cig which will attract only specific excise duty.”

“As per our workings (shown in details on next page), ITC will need to take ~9% price hike to neutralize the excise and VAT hike. However, in order to grow Cig EBIT by 15%, we estimate a price hike of 14% under 2% VAT scenario. Also, ITC can take advantage of this new slab to boost volumes at entry level. For example, it can change the length configuration of lower end brands like Capstan, Bristol, and Berkeleys from 69mm to 64mm. However, we believe it will take time as current portfolio is entirely 65mm plus and ITC will prefer up-trading consumers to premium brands, in our view. We believe some of the price hikes (Classic, Gold Flake Premium) are already in the process of being implemented. (Retailers have started charging Rs120 for Classic).”

“While ITC enjoys absolute market dominance in Cigarette with strong pricing power and has demonstrated consistent growth in Cig profits (Cig EBIT posted 16.8% CAGR in FY06-11 v/s 1.5% in volumes), rising ad-valorem component in taxes can restrict steady margin expansion trend. Given its pricing power and addictive nature of Cig, we see little difficulty in ITC passing through the prices, as in the past, albeit, with lower volumes. We had changed over Cig vol assumption post budget to 1% de-growth v/s our earlier estimate of 2% growth. Maintain BUY,” says Prabhudas Lilladher research report. 

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