ITC - Ad‐valorem makes way for specific; good riddance - Prabhudas Lilladher

Ad‐valorem excise duty structure replaced by Specific: In a silent but significant move, government, through amendments to finance bill 2012, has replaced the newly introduced ad-valorem excise duty structure for Cigarettes to Specific one, albeit with a higher ~21% effective excise increase for ITC, as against the earlier 15% wtd average hike, reflecting successful backstage industry lobbying. Though the near term implications are negative because of higher effective increase for FY13e, long term implications are positive as removal of ad-valorem structure helps ITC retain the benefits of price hikes.

ITC now needs 18% price hikes for 15% CIG EBIT growth: The new excise duty increase (only Basic excise duty is increased, AED and NCCD untouched) varies from 16.6% - 23.2%, highest increase for the 65-70 mm segment. As per our workings, ITC will now need to take ~18% price hike (against earlier 15%) to neutralize ~21% effective excise increase and still maintain its Cig EBIT growth of 15%, assuming a 2% volume decline (we were earlier modelling for 1% volume decline). ITC has already implemented ~12% price increase across its portfolio (price hikes details on next page) barring lower end economy brands. We expect next round of price hikes to include lower end brands too. Post the new specific excise duty, the gap between excise on Cig with less than 65mm and the one with 65-70mm has gone up to ~78% as against the prevailing 45%, creating incentive for ITC to explore sub 65mm territory.

Removal of ad‐valorem is a positive step: Imposition of ad-valorem duty had raised concerns around ITC's ability to manage Cig EBIT margins as it would have resulted in sharing the benefits of price hikes with the government. Secondly, rising ad-valorem component would have acted as key deterrent for ITC's medium term Cig margin expansion and hence would have capped valuation multiples in the future, if not in the near term, we believe. Therefore we see return of specific duty structure as positive notwithstanding the higher effective excise increase for FY13e. We maintain our earnings estimates though we revise our volume forecasts to -2% as against earlier 1% de-growth. Roll forward to FY14e and revise TP to Rs270 while maintaining our BUY rating.

Source : Equity Bulls

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