On Saturday, February 1st, Finance Minister Nirmala Sitharaman proposed new taxes on cigarettes and other tobacco goods during his presentation of the federal government’s 2020-2021 budget. The increased taxes on what is generally referred to as “sin goods” are intended to strengthen the Indian government’s exchequer and help it overcome an ever-widening fiscal deficit.
The proposed levy is expected to lead to an 11 percent increase in taxes on cigarettes and other tobacco products. As a result, cigarette prices overall are likely to rise by between six and seven percent.
Tax Increases Are Welcome News for Public Health Groups
Interestingly, bidis — hand-rolled, leaf-wrapped tobacco products that account for a large amount of employment of low-wage earners — aren’t to see increased taxation at this time. For this reason, Deloitte India’s Anil Talreja believes that the government is aiming the increased taxation at those consumers who are in a position to pay the higher prices.
The minister’s proposal to levy National Calamity Contingent Duty — or NCCD — on certain tobacco products is welcome news to public health groups that have been campaigning for higher taxes on cigarettes to discourage their consumption.
According to India Today, each year in India, more than one million people die as a result of smoking. Furthermore, smoking is the fourth leading cause of non-communicable diseases such as heart disease and cancer, which are responsible for 53 percent of deaths annually. As a result, the authorities have been promoting public awareness regarding health issues associated with tobacco use. They have launched various anti-smoking campaigns and have even required cigarette makers to display large, graphic images on their packaging.
Proposed Tax Increases Cause ITC Shares to Plummet
However, for India’s largest cigarette maker ITC, the proposed taxes were less well-received. During Mumbai trading on February 1st, after the minister’s announcement, shares in the company fell by 6.9 percent to 219 rupees each. On Monday, February 3rd, ITC shares fell for the second straight day for a total loss of approximately 12 percent. It was the largest drop since 2017 when the government introduced the new Goods and Services Tax.
Previous Tax Hikes Caused Sales of Illegal Cigarettes to Flourish
India’s cigarette market is dominated by ITC — known for the Scissors and Gold Flakes brands — followed by Godfrey Phillips India and VST Industries. Although the country’s cigarette market is responsible for $11 billion annually, in recent years, all three companies have felt the consequences of a drawn-out period of tax increases and regulations aimed at reducing smoking. During this time, the illegal trade in tobacco products flourished.
Experts warn that the upcoming increased taxation and associated price increase are likely to further stimulate the illegal trade in tobacco products. The Tobacco Institute of India reports that currently, legally sold cigarettes amount to a mere nine percent of overall tobacco consumption. The remaining 91 percent is made up of products like bidis, chewing tobacco, khaini and illegal cigarettes. In fact, illegal cigarettes make up an astounding 25 percent of the total cigarette market in India.
Despite Diversification, ITC’s Sales Are Likely to Be Adversely Affected
ITC’s sales have been adversely impacted by the dramatic growth in illegal cigarette sales. And despite the fact that the company has been working to diversify to other sectors such as packaged foods, fast-moving consumer goods, and stationery products, cigarettes are still responsible for almost 80 percent of its operating profit. Plus, according to Bloomberg, in the year that ended in March 2019, cigarettes accounted for 46.4 percent of ITC’s annual revenue, which totaled $482,404.5 million. Click here – annual return filing steps and recommendations.
This was a decrease from 66 percent during the same period ending in 2010. Nevertheless, the company’s profit rose 29 percent in the quarter ending in December 2019 due to the diversification drive towards businesses that include agriculture and hotels, amongst others.
After the increased taxation of 2017, ITC only implemented price increases of between three and four percent, which enhanced its cigarettes’ relative affordability and helped maintain sales volumes. Yet currently the company’s flagship brand Gold Flake – which accounts for over half of its overall sales — is at a crucial retail price point. Any increase in price could render the product less affordable for consumers. For this reason, the hike in taxation may have a more severe impact on sales volumes in the near future.
Morgan Stanley Predicts a 10 Percent Price Hike on ITC Cigarettes
Brokerage Morgan Stanley predicts that ITC will settle on a retail price increase of 10 percent to make up for a projected sales volume decline of four percent. This step should ensure that the company’s operating earnings from cigarettes still rise by eight percent over the upcoming fiscal year.
After taking into account the increase in taxes on cigarettes and the expected price hike, Morgan Stanley has now reduced ITC’s earnings estimates for the fiscal year 2021 by one percent and for 2022 by two percent. In addition, it has reduced its price target on ITC’s stock from 370 rupees a share to 340 rupees a share.
Richard Liu is Head of Consumer Sector Coverage at the Institutional Equities Division of JM Financial. He is an expert in the Indian consumer market, as well as the associated nuances. Liu started his career at ITC Limited, first as an Assistant Manager of the Internal Audit division and later as a Corporate Plans Analyst.