ITC tanks on new cigarette policy; analysts say long-term story intact

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ITC tanks on new cigarette policy; analysts say long-term story intact


MUMBAI: The recent rally in the shares of ITC may fizzle out in the short term due to the possible sentimental impact of the draft cigarette policy published by the government earlier this week, but it won’t deter investors with a long-term view on the stock.

The Union Health Ministry earlier this week published the draft Cigarettes and Other Tobacco Products (Prohibition of Advertisement and Regulation of Trade and Commerce, Production, Supply and Distribution) Amendment Act, 2020, which if implemented in its entirety will have long-term ramifications for the cigarette industry.

Major policy changes proposed in the draft bill include increasing the minimum smoking age from 18 to 21 years, a complete ban on public smoking and a ban on sale of loose cigarettes.

That said, analysts believe the government’s draft policy is ambitious and may not ever be implemented judiciously to have a major bearing on volumes and earnings of ITC, which derives 45% of sales from cigarettes.

“On paper it looks negative. In India, there are rules out there for many things but implementation will be a major challenge,” said Abneesh Roy, Executive Vice-President at Edelweiss Securities told ETMarkets.com.

Roy said implementation challenges in making such a policy work on the ground will mean that the impact on cigarette volumes of ITC may not be as high as the Street’s reaction today suggested.

Shares of ITC tanked 2.9% on Wednesday to Rs 205.35 on the National Stock Exchange. Prior to this correction, shares of the soap-to-tobacco maker had risen 30% since November as analysts saw signs of recovery in the cigarette and non-cigarette fast-moving consumer goods businesses.

Market participants fear if the government is able to pass the draft amendment bill soon, it could dampen the recovery seen in the company’s cigarette volumes recently. Moreover, since cigarette business contributes 85% of the company’s profits there could be a meaningful impact.

Analysts, on the contrary, expect implementation-related challenges of such a harsh policy to protect the volumes and sales of ITC from the cigarette business. From the perspective of long-term investors, the policy is already factored in since tobacco-related laws around the world are tightening, analysts said.

“ITC currently is a moderate earnings growth story with a high dividend yield,” Roy said.

OTHER BUSINESSES

ITC has over the years reduced its dependence on the cigarette business by investing in its non-cigarette FMCG, hotel and paper operations.

Brokerage firm Credit Suisse Securities India in a recent note said as double-digit operating margins become visible for the FMCG business, investors can no longer ignore the 55 rupees per share value of the business.

FMCG margins are now within sight of what is considered acceptable FMCG margins. With

2020-21 Ebitda margins likely at 9%, Credit Suisse sees a path to 12% margins over the next five years from this business. I

Further, analysts are betting on the hotel business of ITC to see a sharp earnings recovery in the next financial year as the rollout of COVID-19 vaccines helps improve outlook for the domestic tourism sector.

Much of the negative are already factored in. The dividend yield (of the stock) is very interesting at 6%. ITC is not just a cigarette story,” Roy said.





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