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ITC corrects 6% after 26% rally. What should investors do now?

Any increase in tax on tobacco related products hits the margin of ITC, but the company has power to pass on the cost to consumers by hiking products prices.

October 20, 2021 / 01:32 PM IST
 
 
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A seven-session rally, the market faced a drag from ITC off its record peak on Tuesday. It was perhaps the news of health ministry reviewing the taxation structure for tobacco products that had pulled the share down 6 percent. On October 20, ITC was trading 1 percent down.

The cigarettes business, which accounted for more than 40 percent to the total revenue for ITC, has seen a major relief at least since the Covid period as the government has not majorly tweaked any tax with respect to the tobacco segment.

A revival in consumption demand took the stock up 26 percent in more than a month, making it one of the major contributors to the market rally.

The Union Ministry for Health and Family Welfare has set up an expert panel to review the taxation policy for tobacco products. The panel will develop a proposal for comprehensive tax policy for tobacco products with a public health perspective, the health ministry said on October 19.

Any increase in tax on tobacco-related products erodes the margins for ITC, but the company has always passed on the cost to consumers by hiking products prices. "The demand is inelastic and does not change much due to increase in price as smokers are addicted to it. There can be a knee-jerk reaction but prices move up soon," said Jay Prakash Gupta, Founder at Dhan.

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Likhita Chepa, Senior Research Analyst at CapitalVia Global Research feels the proposed tax structure on tobacco products is expected to put a strain on the margins of the company as cigarettes form a significant chunk of the total business of the conglomerate.

The inflationary pressure, reflected in Hindustan Unilever's operating margin for the September quarter, was also one of the reasons for the correction in ITC, though experts feel the consumption demand is getting improved. HUL was also down over 4 percent in the previous session.

"Most of the FMCG counters are continuously facing the heat of unprecedented input cost inflation and subdued consumer sentiment in the short term. A sell-off in broader markets has halted the stocks' rally and it could be profit-booking," said Ankur Saraswat, Research Analyst at Trustline Securities.

Apart from tobacco business, ITC also operates in several other businesses such as FMCG, hotels, paperboards and speciality papers, packaging, agri products and IT.

"ITC's business verticals are diverse and each of the verticals have potential to create enormous wealth and value for shareholders," said Jay Prakash Gupta.

He further said ITC as a stock has underperformed over the years. The stock is not overpriced given the kind of cash flow it generates. "ITC must spin off its businesses and if that is done it would create a lot of value for shareholders."

Ankur Saraswat feels the stock is available at very attractive valuations. "With rapid vaccination drive leading to reopening of economy and gradual recovery in consumers demand in urban and rural areas, revival of its education and stationary products business, expected revival in hotels business, focusing on cost-saving programmes with richer business and category mix," he explained.

The net profit margin of the company for FY21 has come down to 28.65 percent from previous year's 33.17 percent but the revenue from the operations have been growing YoY. "Therefore, investors can add this stock to their portfolio after a healthy correction," said Chepa of CapitalVia Global Research.

Experts expect its net profit and sales to improve going ahead, though there could be a bit of strain on margin (in cigarette business) if there is a change in tax structure.

ITC will release its second-quarter earnings on October 27. "ITC is expected to see a swift recovery in cigarette volumes and other discretionary business with normalisation of our out-of-home activity. Consolidated revenues are likely to grow at 13.4 percent with an expected 9.4 percent growth in cigarettes sales," said ICICI Direct.

The brokerage expects cigarettes volumes growth of 7 percent. The hotels business is estimated to double over its low-base quarter and the FMCG and paper division is likely to grow 13.4 percent and 12.2 percent, respectively. "We estimate the agri business growth at 6.5 percent on a relatively high base. We estimated 118-bps improvement in operating margins at 35.1 percent and the net profit is likely to grow 12 percent."
Sunil Shankar Matkar
first published: Oct 20, 2021 01:12 pm

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