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ITC: Volume growth disappoints

Oct 15, 2009

In this article, we discuss the performance of ITC’s cash cow businesses, cigarette and tobacco during FY09. Cigarettes and smoking tobacco
New regulations and taxation aimed specially at cigarettes affected consumption during the year in India. As a result, the share of cigarettes in total tobacco consumption reduced, while aggregate tobacco consumption increased. The situation was further aggravated by the extraordinary increase in the rates of Central Excise duty (CED) of the order of 140% and 390% respectively on regular and micro-sized non-filter cigarettes with effect from March 2008. This hike in rates, coming on the heels of a 30% equivalent increase in tax incidence due to the levy of VAT in April 2007 forced the organised cigarette industry to vacate this category. This, in turn, caused a section of consumers to move to revenue-inefficient tobacco products, including smuggled and tax-evaded cigarettes, resulting in a sharp decline in volumes for the highly taxed legitimate sector of the cigarette industry. The vacuum created by the exit of the popular low priced micros and plain non-filter cigarettes was occupied by duty-evaded regular size filter cigarettes which are sold to consumers at Rs.10/- per packet of 10 cigarettes.

  Volume (tonnes) Sales (Rs. m) Realisation (Rs./Kg)
  2009 2008 Growth 2009 2008 Growth 2009 2008 Growth
Cigarettes* 78,370 80,723 -2.9% 151,009 138,155 9.3% 1.9 1.7 12.6%
Smoking tobacco 297 195 52.3% 138 97 41.6% 464.3 499.5 -7.0%
Unmanufactured tobacco 63,642 62,028 2.6% 7,824 5,114 53.0% 122.9 82.4 49.1%
* Volume in million sticks and realisation in Rs/stick;  Source: ITC 2009 annual report

Sale of cigarettes increased by 9% YoY in FY09, while volumes fell by 3% during the same period. Volume for smoking tobacco increased by 52% YoY during FY09 while sales increased by 42% YoY. The operating profit margin for this segment increased from 27.2% to 28.7%. Some of the strategic initiatives during the year to increase sales by ITC include launching of Classic Verve in the king size filter segment and Navy Cut in the regular size filter segment, limited edition pack offerings for Gold Flake Kings and Classic and commemorative packs for most of the other filter brands. The company ramped up its capacity for filter cigarettes to adjust for moving out of the non filter category.

Unmanufactured tobacco
In FY09, there was a large demand for unmanufactured tobacco to replenish diving inventory levels. This coupled with decline in production in almost all major tobacco producing nations resulted in high tobacco prices across the globe. During the year, demand surge led to increase in farm prices, making tobacco one of the most remunerative commercial crops for the year.

During FY09, the sale for unmanufactured tobacco grew by 53 % YoY while the volumes grew by 3 %YoY. Exports of tobacco grew by 51% YoY. ITC was able to capitalise on the growing demand for tobacco through a combination of new business development and customised product and service offerings to both existing and new customers

What we expect?
At a price of Rs. 252 ITC is trading at 22 times our estimated FY12 earnings. With heavy taxation on non filter cigarettes, the company took steps to arrest fall in volumes and sales. ITC achieved this by launching existing filter brands in different sizes. While this helped push up sales, the company could not entirely regain volumes lost in non filter category and net-net the company lost volumes in cigarettes. In case of unmanufactured tobacco, the company was able to very well due to worldwide shortage of tobacco. Going forward we believe that the company’s cigarette numbers will be under pressure due to new regulations like pictorial warning on cigarette packs and ban on smoking in public areas. The tobacco demand and supply situation is expected to be in equilibrium in the medium term due to incremental production in key tobacco producing geographies. Hence, going forward, we do not expect ITC to make such extraordinary profits in unmanufactured tobacco category.

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