Understanding the Union Budget’s Impact on ITC

For ITC, the budget has always been a significant event. That’s because the Union Budget builds expectations for a possible hike in taxes on tobacco and tobacco products.

ITC is a leading seller of cigarettes (8 out of 10 cigarettes sold legally are from an ITC brand). So during Budget ’23, when the Finance Minister stated that the tax on tobacco products would be hiked by 16%, a sell off caused ITC’s stock drop to by 5% within a few seconds. However, this was short lived, since investors realized that while 16% sounds steep, the impact was just ₹0.51 per cigarette. ITC could pass along this extra cost to the consumer, increasing the price of cigarettes by a mere 1–2%.

Consequently, ITC’s stock rallied on 2nd February 2023 and reached its all-time high.

ITC’s past relationship with the Union Budget

While taxation on tobacco is primarily under the purview of the GST Council (current GST on tobacco products is 28%), the central government also levies a National Calamity Contingent Duty (NCCD) on cigarettes, which is subject to changes in the Union Budget. This makes the Budget an important event for ITC stock, as cigarettes constitute more than 80% of the company’s net profit, and about 40% of its revenue.

Historically, ITC’s stock has underperformed prior to the Budget due to apprehension among investors about tax hikes and its consequent impact on earnings. Prior to this year’s budget, shares of ITC had given negative returns 7 times out of the last 12 Budgets.

The worst fall for the stock was in February 2020 ahead of the Budget for 2020-21 (April-March). The stock shed nearly 9% on expectations of a steep hike in taxes. In the Budget for FY21, the government had increased NCCD by 2-4 times resulting in tax hikes of 9-15%.

Despite this, ITC was one of the best performing index stocks. In 2022, the stock has gained more than 52%, outperforming most of its peers and the benchmark index Nifty 50.

ITC’s dominance in the tobacco Industry

Smokers make loyal clients. They enjoy their particular brands and each consumer has their different tastes. They’ll even pay a higher price if required for their desired brand. The company has an expansive distribution network which it has built over the past 100 years and boasts of over 7.1 million outlets for tobacco product sales (double the number of outlets of its nearest competitor).

We must also keep in mind that ITC continues to innovate. They already have a five-pack of cigarettes available. They are aware that single sticks of cigarettes make up 75% of the market in India. People choose to purchase singles since it is simpler and less expensive. ITC is thus attempting to increase the size of its potential client base by decreasing the packet size. If the rumors are accurate that the Indian government will outlaw the selling of single sticks nationwide, ITC is bound to be ready. It won’t readily give up market share to the illegal cigarette trade.

But the stock can’t just be driven by its tobacco business, can it?

Take their FMCG business for instance, in which they have a range of personal care products, biscuits, and even instant noodles. ITC has built all this from the ground up. They’ve developed these products as well as built a robust supply chain for their distribution. The products are also heavily marketed and command high brand awareness.  

However, ITC’s net margins on these products have been quite poor, typically at just 2–3% while its peers command over 15%. But that’s slowly changing and these net margins have inched upwards to nearly 7%. Investors expect this to keep improving.

ITC’s hotel business is typically capital-intensive and doesn’t yield a lot of profits. They have, however, tweaked their strategy to no longer go out on a spending spree to acquire hotels anymore. They want to be more asset-light and are now building up their portfolio of hotels by entering into contracts to simply manage existing properties owned by others. This way, ITC keeps its foot in the hospitality door but shells out less cash in the process. With tourism and conferences picking up post-pandemic, the wind is blowing in favor of their hotels business too.

ITC also has an agri-business manufacturing frozen peas, shrimps, and paper (Classmate brand of notebooks).

It’ll be quite interesting to see how ITC’s future pans out.

How can you invest in ITC?

Currently, ITC is a part of six Windmill Capital smallcases. You can choose from these smallcases based on your risk appetite and investment goals.

You can check out Windmill Capital smallcases that include ITC here:

Brand Value smallcase by Windmill Capital

Value & Momentum smallcase by Windmill Capital

Dividend Stars smallcase by Windmill Capital

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Users must make their own investment decisions based on their specific investment objective and financial position and using such independent advisors as they believe necessary.

Windmill Capital Team

Windmill Capital Private Limited is a SEBI registered research analyst (Regn. No. INH200007645) based in Bengaluru at No 51 Le Parc Richmonde, Richmond Road, Shanthala Nagar, Bangalore, Karnataka – 560025 creating Thematic & Quantamental curated stock/ETF portfolios. Data analysis is the heart and soul behind our portfolio construction & with 50+ offerings, we have something for everyone. For more information and disclosures, visit our disclosures page here –https://windmillcapital.smallcase.com/#disclosures