Price hikes for cigarette brands offset margin concerns for ITC

Stock trading at 25 times its FY20 estimated earnings; increase in costs unlikely to weigh on volumes

The recent price hikes on ITC’s cigarette brands have cheered the Street, with the company’s share price gaining close to 2.7 per cent over the last two sessions. ITC has increased prices of Flake Excel, Bristol and Capstan cigarettes by 7-15 per cent, as well as those of select other brands. The first three products alone account for 20 per cent of ITC’s overall cigarette volumes. However, the average price hike for the cigarette portfolio is estimated at over 2 per cent.

Despite in-line numbers for the December 2018 quarter, the stock has declined over 4 per cent after announcement of results and till the recent price hikes. The fall was a tad higher than a 3.7 per cent fall in the BSE FMCG index during the same period. Concerns over its cigarette business’ profitability, amid dearth of price hikes, have weighed on investor sentiment.

Accounting for close to 85 per cent of ITC’s overall operating profit, the cigarette segment’s Ebit (earnings before interest and tax) margin had contracted by 107 and 50 basis points, year- on-year (YoY), in the September 2018 (Q2) and December 2018 (Q3) quarters, respectively.

However, the recent price hikes — including other small price increases in regional brands in Q2 and Q3 — have come despite no increase in taxes. Thus, this will improve realisation and operating profit margin, provided there is no tax increase going ahead, besides offsetting the increase in tobacco costs.

Roughly, a 2 per cent price hike will result in about a 4 per cent improvement in realisation. Though the higher cost of tobacco could cap benefits to an extent, some analysts estimate a double-digit growth in ITC’s cigarette business’ operating profits in the near term. During the AprilDecember 2018 period, the cigarette business’ Ebit rose 9 per cent YoY.

An important aspect is that the price hikes are unlikely to weigh on volumes.

“ITC has been taking price hikes in some regional brands since the September 2018 quarter. Since the pricing actions are restricted to regional brands, we do not see any material impact on volumes. Further, 20 months of steady prices provide comfort on price hikes,” says Nitin Gupta, analyst at SBICAP Securities.

During April-December 2018, average cigarette volumes growth was close to 5 per cent against a 3 per cent fall during the same period a year ago. The past trends suggest that single-digit price hikes usually do not impact volumes significantly.

The stock is currently trading at 25 times its FY20 estimated earnings.