Tobacco stocks rallied in trade on Thursday, September 4, even though Finance Minister Nirmala Sitharaman announced that cigarettes, along with paan masala, gutka, and other tobacco products would be levied with a 40 percent Goods and Services Tax (GST) rate.
"That special rate of 40 percent has also been proposed, and it's been cleared and will apply only to paan masala, cigarettes, gutka, and other tobacco products such as chewing tobacco, products like zarda, unmanufactured tobacco, and beedi," the finance minister said during the 56th GST Council meeting on September 3.
Brokerages believe the move will be either neutral or positive for tobacco companies. Currently, tobacco is currently taxed at 28 percent GST plus cess, which is a mix of specific and ad valorem duties. The combined total of all taxes levied is around 50-55 percent of the MRP.
This has result in tobacco stocks cheering in trade. At 10 a.m., ITC, VST Industries, and Godfrey Phillips India shares have gained between 1-4 percent in trade.
Post this implementation, no compensation cess will be levied; however, it is not clear at this stage whether National Calamity Contingent Duty (NCCD) (which is separate from GST) will continue, noted Jefferies. However, if there are no additional levies implemented, beyond the revised GST rate of 40 percent, it is positive for the tobacco space.
Even if NCCD continues at the current rate, the total tax incidence on cigarettes will be lower by five percent, based on our understanding, said Jefferies. "However, in the context of timelines, we need to see if government levies any other form of taxation to offset this benefit. If revised lower tax is confirmed, we expect tobacco industry to take down prices which would make them competitive against illicit competition and help gain share."
Steady taxation in the last few years helped arrest growth in illegal volumes, with accelerated growth in legal volumes being a positive for the government. "We see steady taxation as the base case scenario, where the government may hike the basic GST rate to 40 percent (from 28 percent) on value addition or MRP and shift the balance incidence to NCCD," said domestic brokerage Emkay Global.
Nevertheless, ITC shares have come under selling pressure over the past year, falling 16 percent. According to Emkay, the correction can be attributed to concerns about an increase in cigarette taxation, along with competitive pressure from Godfrey Phillips (GPI), which has gained ~300 bps of market share from ITC. Further, inflation in prices of tobacco leaf has impacted ITC's EBIT margin.
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