The Union Cabinet has approved introduction of a bill seeking to prohibit tobacco advertising (in sports and cultural events), sale of tobacco products to minors and also smoking in public places. Letís analyse what this bill holds for tobacco major and market leader ITC Limited.
ITC controls around 70% of Rs 80 bn Indian cigarette market. The company boasts of one of the largest distribution networks in the country, which has enabled it to reach out to even the remote corners of the country. Of the six top brands in the Indian industry, ITC owns five.
The company had been hard pressed to achieve volume growth in cigarettes, owing to punitive taxation and ban on smoking in railway stations. The bill will further impact sentiments in the longer-term, as volume growth will become even more difficult to achieve.
As a result, ITC's profit growth will be more a function of price increases and also based on the returns its gets from its other businesses of hotels, packaging, retailing and infotech. But all these businesses will take some time to offer returns and even these returns are unlikely to match those of ITCís cash cow business of cigarettes. But in the near-term the performance of the company is unlikely to be adversely affected.
For one, a ban on public smoking will be difficult to implement. When a ban on smoking at railway stations was introduced a couple of years ago, it hardly impacted cigarette volumes. Besides, the prohibition of tobacco advertising in sports and cultural events may infact work to the advantage of ITC. ITC already has a
massive distribution reach and the consumers know its brands. For the smaller players and new entrants (like Philip Morris), the prohibition on advertising will serve as a huge entry barrier. It will be that much more difficult for these companies to promote new brands as compared to ITC.
In the near term, the ban on advertising will also bring cost benefits. ITC spends around 5% of its net turnover on advertising. A significant portion of this is spent on cricket and other sports sponsorships. The ban will thus reduce its advertising outgo, and hence improve its profitability.
However, in the longer term the scenario for the tobacco industry looks a shade negative. If the bill is passed, it more or less confirms that the state is against the cigarette business. It will also mean a lesser addition in the number of customers. Also, with the government looking for ways improve its finances post the Gujarat earthquake, it is likely that the cigarette industry will also be slapped with a higher excise duty.
All this is negative news for ITC. The company has recently hiked prices of its products and hence, will find it difficult to pass on the excise hike, if it comes. This will prune its realisations in FY02. The bill however, is yet to be passed by the government. If however, whatever has been proposed is passed, we will have to relook at ITCís FY02E and FY03E numbers again.
At the current price of Rs 789, the stock trades at a P/e multiple of 20.5 times its annualised nine month FY01 earnings.