Due to their relatively high base, cigarette stocks would see mid-to-high single digit volume growth in H2FY23, said Sanjay Manyal, Senior Research Analyst, ICICI Direct.In an interview with MintGenie, Sanjay said the taxation on cigarettes will generally remain consistent in the 2023 budget, taking the last five years into consideration.
Edited excerpts:
1. Currently, tobacco stock prices are trading in the green. What are the main factors influencing these stocks' constant performance?
Cigarette volumes were adversely impacted in last two years (FY20-FY22) due to lack of mobility during Covid-19. However, increased mobility post Covid and stable taxation resulted in cigarette volumes surpassing pre-Covid levels in H1FY23. We believe, industry wide cigarette volumes are higher by 10-12% from Pre-Covid period. In last one year, Rs. 10 price point cigarettes are gaining strong traction due to ease of coinage. Further, crackdown on illicit cigarettes supply chain is also helping cigarette companies in re-gaining market share from illicit & contraband cigarette brands.
2. Do you anticipate a rise in cigarette taxes in the 2023 budget?
Cigarette Industry saw considerable volume decline in last two years due to Covid, which in turn also adversely impacted ex-chequer income (Excise, GST, Cess) from cigarette companies. We believe taxes on cigarettes would remain stable given increase in taxation generally leads to consumption shift towards contrabands.
3. Will the cigarette stocks' upward trend continue in 2HFY23?
We believe H2FY23 would see mid-high single digit volume growth, due to relatively high base. This is compared to 20%+ volume growth in H1FY23 (Covid impacted base). However, mid-single digit volume growth in cigarettes is considered strong growth given cigarette volumes have remain flat in last decade impacted by excessive increase in taxation specifically during FY12-FY18.
4. What's your outlook for the tobacco pack for the upcoming quarters?
We believe taxation on cigarette would largely remain stable taking into account last five years precedence. Since GST implementation, excise duty on cigarettes have only increased once in 2020 Budget. We believe cigarette companies would see mid-single digit volume growth and higher volume contribution from ₹10 price point cigarette brands would also aid price realisation. This would lead to strong profitability growth going forward
5.What are your top stock picks in this sector, and why?
We are positive on ITC given it has been able to gain market share not only from contraband brands but also from other cigarette companies (VST Ind) brand. Moreover, ITC’s FMCG business is poised to grow at a faster pace given higher proportion of foods business. Currently FMCG business margin is ~9% which is expected to see 100-150 basis points margin improvement every year. Also, paperboard and hotels business are also witnessing extremely strong growth in post Covid-period.
6. According to reports, many global investment funds have started considering environmental, social, and corporate governance (ESG) score of a company as a big factor behind their investment decision. With trend picking up, do you believe cigarette stocks will continue to hold the same significance as now? What is likely to happen with these companies?
Globally tobacco stocks were de-rated in last decade mainly due to ESG concerns & increasing trend of e-cigarettes. Cigarette companies in India also underperformed in similar period due to ESG concerns. However, cigarettes stocks in India are trading at 40-50% discount to FMCG companies. Though we believe cigarette stocks would not command similar multiples to other FMCG companies but strong volume growth & expected margin expansion would shrink this valuation multiple discount in future.
