Accumulate ITC Ltd. - Kotak

The amendments to Finance Bill make significant changes to the excise duties of cigarettes: Finance Minister, in introducing amendments to the Finance Bill for budget 2012-2013, has made significant changes to the excise duty structure of cigarettes. In summary, the amendments do away with the ad-valorem duty imposed on cigarettes for the first time, and introduce taxes that are, on average ~21% higher than rates applicable for FY2012 (see details on the next page).

Steep hikes in duties, likely to impact volumes, or margins: The excise duties as per the amendments are the most significant in the past decade. A 21% hike in duties implies that ITC shall have to take up (further) hikes in order to maintain margins. Either volume growth or margins shall weaken, going forward, on an incremental basis, from prior (budget FY13) proposals.

Benefits of new <65mm slab could help offset volume weakness; return to specific duties a positive: The union budget had introduced a new slab of <65mm. This is maintained post the amendments to the Finance Bill. The same could help offset to a modest extent, the weakness in volumes that shall follow price hikes. We believe a return to specific duties is a positive for ITC as it provides the company greater flexibility in the management of margins.

ITC has raised prices significantly in preparation/ post budget event; near-term impact on earnings will be modest: ITC has raised prices significantly pre and post union budget FY2013. The company has raised prices of brands such as Wills, Gold Flake, and Bristol by between 10% and 25%. Given that the new structure, on a blended basis, shall be higher 3-4 ppt from the union budget, we would expect that the hit on company's earnings shall be modest on an incremental basis. We continue to believe in the pricing power that ITC enjoys. Our FY13 EPS, assuming lower volume growth in FY13, is revised downward by 2%.

Hike raises questions about government's view on cigarette taxation, is a near-term negative: For sentiment, more important than the immediate question of excise duty hike, is whether the present government of India, may see cigarettes as an easy target of gathering revenues in the short-term. Proposals made in the budget, and now in the finance bill amendments, indicate that this is likely; given weak fiscal position, and the relatively minor political repercussions that taxation on cigarettes are likely to have. The same could be sentimental negative for the stock.

Near-Term Declines may provide attractive entry points: There is a possibility of further near-term declines in the stock (following yesterday's declines). Given our views on long-term stability of excise duties, we remain positive on ITC with a medium/ long-term view, and would use lower prices as entry points into ITC.

Change in Price Target, Maintain ACCUMULATE: We believe that ITC shall be able to pass on the hikes in duties, with modest impact on margins. We would be buyers into near-term declines of ITC. Our March 2013 price target is Rs 238 (Rs 220 earlier), on FY13 PER of 27x.

Source : Equity Bulls

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