ITC: VAT increased to 25% in Maharashtra, 55% in Punjab

21 Mar 2013

Update |Sector: Consumer

ITC

CMP: INR307

TP: INR 340

BUY

ITC: VAT increased to 25% in Maharashtra, 55% in Punjab; “20%

Cig EBIT growth – come rain, come shine” theory at risk

(ITC IN, Mkt Cap USD43b, CMP INR307, TP INR340, 11% upside, Buy)

‐

VAT hikes by state governments continue in the budget season. Maharashtra

and Punjab joined the bandwagon and increased VAT on Cigarettes from 20% to

25% and 22.5% to 55%, respectively.

‐

So far 10 state governments have increased VAT rates and cumulative impact

works out to 400bp, as per our workings (depicted in the VAT table below).

Clearly the pace of VAT increases this year seems the highest in last five years –

underscoring the precarious financial position of various state governments.

‐

This coupled with 18% excise increase in the budget makes the going tough for

ITC notwithstanding its excellent track record of ensuring Cig EBIT growth

despite lower Cig volume CAGR over FY07‐12.

‐

Our earlier assumption of 2% volume growth, 14‐15% Cig price hikes and 16%

Cig EBIT growth is at risk. Given the higher than expected VAT increases, we now

estimate 18% Cig price increase to maintain 16% Cig EBIT growth. Therefore,

volumes could be lower than what we are currently modeling, more than offset

by price hikes, ensuring no material change in EPS estimates.

‐

Thus, two consecutive years of mid teens Cig price hikes (FY13 price hikes

aggregate to 17%) is not only unprecedented but it also puts the ongoing 20%

Cig EBIT growth momentum at risk. While Cig demand still remains inelastic,

pushback to price hikes has relented over the years and ITC’s pricing power

remains undisputed, we believe continuance of flattish volume growth can have

implications for ITC’s premium valuations.

‐

We currently have a BUY rating on ITC with a TP of INR 340.

ITC ‐ Maharashtra & Punjab Budgets ‐ VAT increased to 25% in Maharashtra and

55% in Punjab

‐

Maharashtra has increased VAT on Cigarettes from 20% to 25%. It contributes 8‐

9% of Cig volumes. Maharashtra is the 10

state to increase Cigarette VAT in

FY14.

ITC

‐

Punjab also increased Cigarette VAT today from 22.5% to 55% including 10%

surcharge.

Kerala has recently increased VAT from 15% on invoice to 20% on MRP.

Weighted average VAT now stands at 24.7%, as per our workings.

The

total

impact of VAT increases taken so far is 400bp YoY.

Tamil Nadu will be presenting its budget on 21 March.

Assuming both TN and Delhi increase the excise to 25% from current 20%,

weighted average VAT for ITC will be 25.5%, as per our workings.

Excise increase of 18% in Union Budget coupled with VAT hikes mean ITC will

need ~15% price hike to neutralize the impact. As in the past, we expect ITC to

take price hikes higher than required to maintain its 15% plus Cig EBIT growth

momentum.

Our workings suggest 18% price hikes for 16% EBIT growth

21 Mar 2013

ITC

Valuation & view:

“20% Cig EBIT growth – come rain, come shine”

theory at risk

‐

We believe our volume growth assumption of 2% for FY14E has clear downside

risks. However, if price hikes are higher than our estimates, there could be

minor upside risks to our EPS estimates.

‐

Post budget we had built in 2% volume growth, 14‐15% price hike and 16% EBIT

growth for FY14E.

‐

However, given the higher than expected VAT increases (we had earlier built in

23% weighted average VAT for FY14E, +230bp YoY), now ITC will need ~18%

price hikes for 16% EBIT growth.

‐

Two consecutive years of 18‐20% price hikes is unprecedented and hence will be

difficult to maneuver even for an inelastic and addictive category like Cigarettes,

in our view.

‐

We believe

“20% Cig EBIT growth – come rain, come shine”

theory is at a risk.

‐

We will tweak our estimates once the TN and Delhi budgets are out of the way.

However, we do not see material change in EPS estimates though volume‐

pricing equation can change.

We currently have a BUY rating on ITC with INR340 price target.

Cig vol growth (%) flat despite ~17% price hike in FY13

Cig EBIT consistently grew in high teens

Cig EBIT margins have expanded consistently

21 Mar 2013

ITC

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21 Mar 2013