Budget 2023: Will ITC shares take a hard hit from any upward revision in cigarette tax?

A couple of brokerages see probability of a hike in cigarette tax this coming Budget. The last tax hike was announced three years ago. Nuvama Institutional Equities said that there has been a laudable recovery in legal cigarette volumes this year, but noted that most other parts of consumption have seen sharp inflation in the past three years. It believes consumers are likely to accept moderate hike in cigarettes tax (below 12 per cent).

For now, the average target price for ITC based on 34 commendations stood at Rs 373.92, as per data available with Trendlyne, which suggests a potential 12 per cent upside for the stocks. Analysts, for now, are maintaining their price targets.

"Any tax hike beyond 12 per cent may have an adverse market dynamic impact allowing space for illegal cigarettes to occupy market share. Although the probable tax hike keeps us cautious for the near-term, we retain ‘BUY’ with an unchanged TP of Rs 400," Nuvama said.

Jefferies said it expects momentum in the cigarette business to continue, with ITC delivering 15 per cent cigarette Ebit growth in FY23 and 10 per cent in FY24.

"Union budget in February however does create some near-term uncertainty on a potential change in tobacco taxation - our base case builds in a 5 per cent YoY tax hike in the Upcoming Budget," Jefferies said.

Prabhudas Lilladher is expecting a 5-10 per cent hike in cigarette excise duty.

Nuvama noted that during FY13 to FY17, duty on cigarettes was increased sharply at a CAGR of 15.7 per cent, but tax revenues from cigarettes grew a mere 4.7 per cent CAGR.

Thereafter, relative stability in taxation was observed until January 2020, with revenue collections growing 10.2 per cent.

The budget for FY21 increased the National Calamity Contingent Duty (NCCD) by 2-4 times across cigarette stick sizes, resulting in tax hikes of 9-15 per cent. A sharp tax hike beyond 12 per cent could push consumers to smuggled cigarettes, Nuvama said.

Nuvama noted that the share of legal cigarettes in total tobacco consumption declined from 21 per cent in 1981-82 to a mere 8 per cent. Despite accounting for less than one-tenth of the tobacco consumed in the country, duty-paid cigarettes contribute more than four-fifths of the revenue generated from the tobacco sector, it noted.

"After a bumper Q2FY23, tax hikes keep us cautious for the near-term, hence the Union Budget on February 1 will be a key monitorable. After the surprise rate hike in GST few years back, there has been no change in rates during the GST regime. However, the NCCD tax hike announced during the union budget 2020 raises risk of a hike," it said.

For the December quarter, Kotak Institutional Equities is modelling in 9 per cent YoY growth in cigarette volumes (4.5 per cent on a 3-year CAGR basis versus 5.1 per cent last quarter), largely driving 12.3 per cent YoY growth in cigarette sales. It forecast 13.3 per cent YoY growth in cigarette EBIT in the December quarter.

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