No surprise then that the stock has remained weak all through January ahead of the February 1 Budget announcement, after staging a 26 per cent rally in November and December.
This time around, there are heightened concerns after the government proposed a new cigarette policy that could severely dent the prospects of the industry, which makes up for majority of ITC’s operating profit.
For months the chatter on the Street has been that the government may look at increasing the tax on tobacco products in order to shore up revenues that have been deflated by the economic hardship caused by the Covid-19 pandemic.
Traders have developed cold feet, and sharply increased short positions in February futures contracts of ITC, suggesting that they fear a tax hike in the Budget.
Since January 19, open interest in February contract of ITC has risen more than three times while the price of the stock has declined 5 per cent.
That said, here are a few possible scenarios that can play out for the cigarette companies this Budget.
Some analysts believe the government may not have the need to hike the GST rate on tobacco products, as was being feared earlier in the financial year, as GST collections have seen a sharp rebound in the past few months.
Edelweiss Securities noted that Finance Minister Nirmala Sitharaman had said that demand conditions were not rosy enough for GST hikes. Further, the brokerage noted there was an already notable tax hike on cigarettes in the previous Budget.
Brokerage firm Credit Suisse Securities India believes if the government were to go in for a tax raise, then investors may not mind a hike in the vicinity of 5-7 per cent. The stickiness of cigarette demand will allow companies to pass on the hike to consumers without denting volumes, analysts said.
Analysts believe in the worst case scenario, the government could raise the tax on tobacco products by more than 10 per cent to further give cushion to its revenues as well as to achieve the social objective of discouraging cigarette use.
Brokerage firm Axis Securities said if the government imposes a Covid-19 cess or hikes national calamity contingent duty by more than 10-15 per cent, then the impact on the cigarette manufacturers will be adverse.
Another known unknown may also play out for the cigarette companies in this Budget. Brokerage firm Edelweiss Securities believes investors should be concerned more about what the government has to say about the new cigarette policy.
“If the draft bill goes through, it would potentially cause further headwinds for the industry; and in particular it would make it more difficult to add consumers. This would affect volumes, as it calls for the sale of only sealed and intact packs,” the brokerage said.
Keeping aside the uncertainty around cigarette taxation, brokerages remain positive on the outlook for ITC, as the company continues to show signs of reducing its dependence on the cigarette business.
“ITC’s FMCG segment is possibly one of the most under-appreciated businesses in the Indian consumer space in recent times, in our view. We suspect the market may not have taken a holistic look yet,” brokerage firm JM Financial said in a recent note.
The brokerage believes ITC’s valuation at 15-times two-year forward earnings is “extremely compelling” given the 5 per cent dividend yield, over Rs 36,000 crore cash and prospects of the non-cigarette FMCG business.
Given the improving long-term outlook, if the best-case scenario on taxation plays out for ITC, then investors can count on a large short-squeeze on the counter post Budget.