With less day-after smoke, cigarette stocks light up

Sub-65 mm sticks, on which the excise rise is 72%, aren't a major part of volumes for most manufacturers

A day after one of the steepest of rises in excise, of 11 to 72 per cent proposed by the government, major cigarette stocks actually closed higher, even as the Sensex shed 348 points.

Reason: The sub-65mm sticks, on which the excise rise is 72 per cent, is not a major part of the volumes for most leading tobacco companies. “Most of the players have a smaller stake in the sub-65mm sticks, apart from VST Industries; the rest of the excise hike is within manageable limits of major players. ITC, the largest cigarettes manufacturer, has seven to 10 per cent of its volume in smaller cigarettes, so the price hike would not be too steep for the company to pass on,” said an analyst with Sharekhan.

ITC sells three of every four cigarettes in India. The 65-70mm category is its major area, according to a Prabhudas Lilladher research report. ITC itself did not want to comment but its stock closed a little over one per cent higher on the BSE exchange on Friday, at Rs 346.

The excise rise of 11-17 per cent on longer sticks was less than what the market had anticipated, say analysts

The excise on cigarette sticks had been raised by 18 per cent in the 2012-13 Budget and 20 per cent in that of 2013-14. In 2012, the government had introduced a 40 per cent lower tax slab for the sub-65mm segment, which prompted all major players to launch smaller sticks.

Godfrey Phillips had extended most of its 69mm brands to the sub-65mm segment. The idea was to take advantage of volumes. It closed 4.1 per cent higher on the BSE, at Rs 2,708.95. VST Industries closed 3.15 per cent higher, at Rs 1,499, though sub-65mm sticks have a pie of close to 60 per cent in VST Industries’ volume scenario, analysts claimed.

On the face of it, the 72 per cent excise rise seemed steep but its impact could be limited. A 17 per cent rise would be implemented for 65-70mm. The lowest excise rise of 11 per cent would be implemented on 70-75mm sticks; 84mm ones would attract a rise of 21 per cent.

While the rise might not be a major concern, the overall volume decline was likely to stay for even ITC, most of the analysts said. A research report by Prabhudas Lilladher said, “We note that this is a third consecutive year of steep excise increase, a phenomenon not seen in the past 20 years at least. We believe another round of 15 per cent price increase, post the 40–50 per cent increase of the past two years, will be negative for volumes in the near term. Although ITC has strong pricing power and market leadership, a blatant excise increase in the first year of regime change does not augur well for sustaining 16–18 per cent Ebit CAGR (compounded annual growth in earnings before interest and taxes) in the cigarettes business. Although an upturn in the economy might reduce fiscal pressures in the future, the risk to the profit growth of ITC seems higher than in the past few years.”

The average price rise for ITC would work out to be around 21 per cent , analysts said.   

The Tobacco Institute of India argues the excise rise would fuel growth of illegal trade in cigarettes. “Cigarettes represent only 15 per cent (12 per cent for legal cigarettes) of tobacco consumption. Bidis, along  with other tobacco products like chewing tobacco, khaini, etc, represent 85 per cent of consumption in India, much more affordable as they are either taxed lightly or not at all.

The extremely high increase in excise duty rates on cigarettes, coming after sharp increases in the two preceding years, will strongly incentivise and promote accelerated growth of the international smuggled and domestic tax-evaded illegal cigarettes, which are together a significant 19 per cent of the total cigarette  industry in India.

Worldwide, there is a strong nexus between cigarette smuggling and criminal activity. It is now established that such illegal trade in cigarettes leads to a loss of Rs 6,000 crores for the Indian Exchequer annually,” it noted.