FDI Ban on Tobacco: How Will it Impact ITC?

Source from:  Moneycontrol.com 04/28/2010

ITC is the country's leading cigarette company and has taken hard the substantial excise hike announced this budget. Add to that the inflationary environment that could hurt demand in its other FMCG businesses such biscuits and personal care. On the flip side, the recent ban in FDI on tobacco may help ITC keep foreign competition at bay. The company expects cigarette volumes to fall this year as a result of the sharp increase in taxation-excise and state levied VAT. In an exclusive interview to CNBC-TV18's Menaka Doshi, ITC's Executive Director, Kurush Grant says traditionally in such years, a revival is possible in the second half of the fiscal. Below is a verbatim transcript of an exclusive interview with Kurush Grant on CNBC-TV18. Also watch the video. Q: What did you make of the FDI ban? A: We have been in India for the last 100 years, but Philip Morris has been in India for the last 75 years. Japan Tobacco has been in India certainly five-ten years or maybe more then 10 years. You had in the past Rothmans came into India. So are foreign companies selling cigarettes in India even today and the answer is yes, they are. Q: Are you saying that there are not that many foreign companies left that might want to come to India and therefore in effect this ban doesn't achieve anything? A: It's a good question because internationally there has been massive amount of consolidation in the tobacco industry. Obviously, the largest tobacco company in the world is the Chinese National Monopoly. China is largest for anything at all. So if you exclude them you have got Philip Morris based in Switzerland, Altria in US, British American Tobacco (BAT) in UK, Imperial Tobacco and KT&G. Outside these five-six companies there aren't many international companies operating in the cigarette space because consolidation has been so wide and widespread over the last decade that between these six companies and CNTC, which is a China National Tobacco Corporation, the bulk of the cigarette market worldwide is covered. You have few so-called independent companies and ITC being one of them. There is Turkish monopoly which was independent and is been bought over. There are independent companies in Egypt and Thailand. Q: Are you saying that there wasn't anyways a long line at the door, so they are not effectively keeping many players out? A: Absolutely. Q: It also does in some twisted fashion give you a defence against BAT if it were to turn hostile because now BAT cannot come in and try and acquire any more equity? A: BAT is a shareholders of the company and as is several government agencies and as is the general public. Shareholding patterns in ITC have been fairly constant for a fairly long time. I suppose that's the way it will continue. It hasn't affected any of the stakeholders' interest one way or the other. Q: Everyone remembers skirmish with BAT? I am saying that potential replay of that skirmish is been ruled out at least because BAT cannot indirectly increase its stake? A: No company would ever want to have a skirmish with any stakeholder, let alone shareholders so why should that ever be an issue. Q: In some senses it provides you a defence against any foreign hostile. Is there any potential foreign hostile takeover if at all? A: ITC is unique in India to one extent and perhaps Larsen & Toubro is the only other company who does not have one single malik. We are the only company whose malik, who do not have a single malik that owner or malik could be an Indian entrepreneur or foreign multinational. In the case of ITC our owner has always been the market and that is going to continue. Q: Moving to the other space which is a big whammy in the Budget that was announced at the end of February with regards to the increase in excise on cigarettes and especially the sharpest increase came or the biggest increase came in on the category of regular which is where most of your volume happens. What have the implications of that been or what are they likely to be in terms of volume growth over the course of this fiscal year? A: Last such steep increase in taxation took place in 2007 with the introduction of VAT on cigarettes. In that year it was not only introduction of VAT but even excise went up so it was a very sharp increase and certainly the cigarette industry came down-it dropped down by 4% or 5%. It then started picking up again over the last two years. In fact, in 2008 it also came down slightly because the excise on non filter cigarettes went up very dramatically. It grew last year. I suspect it's going to decline once again in 2010-2011 and depending on what happens in terms of excise duty and other taxation later on-what rate of GST finally comes in from April 1, 2011-will decide whether the cigarette industry bounces back in volume terms. What is interesting however is that there is a very clear-cut correlation between economic progression and growth of cigarette industry. In fact the NCAR rated- the if I am not mistaken-it had a co-relation of 96-97% its just that high. So what happens is that if the economy improves which I am sure its bound to improve, there will be more and more movement hopefully from other forms of tobacco to cigarettes. If tax rates go up it will come down again, it's a game lets put it that way. Q: Can I urge you to put a number to that decline in any fashion? A: Difficult to say, but we have had declines in the past for. In 2001-2002, the industry declined by around 6-7%, in 2007 around 4-5%, so you had examples but you also had examples in mid-90s where in spite of large increase in excise the industry did not declined. So it's impossible to say. Q: This focuses on the dependence of the performance of the non-cigarette FMCG business then increases if you are going to see a difficult year in the cigarette business. So I want to come to the non-cigarette FMCG business. How do you characterise the demand environment right now when it comes to non-cigarette FMCGs which is biscuits, packaged foods as well as personal care? A: In a way it's very similar the cigarette industry. As the economy improves and grows, consumption of FMCG goods and packaged consumer goods will increase. It depends on how quickly the economy grows and how widespread the growth in the economy is. When I say widespread, you can have 9% growth rate or 10% growth rate which is concentrated in few areas either geographically or demographically, whereas you can have a 7% growth rate which is spread across over wider demographic band in the country. For the packaged goods industry and for the FMCG industry, the wider the spread of economic growth the better the growth rate is. Q: What is the impact of the food inflation over the last three months because in the late last year's interview that I did with you when we weren't seeing such a dramatic food inflation number and in fact that time we were still talking about comparative year on year input prices being more favourable. In the last three-four months things have changes dramatically (a) you have seen food inflation is that impacting demand (b) you have seen input prices go up. So how is that change? A: It's very interesting and you got a very strange situation today. We suspect and the Government of India also suspects that India is going to have wheat coming out of its ears. The crop will look very good and we are seeing signs of that. So we are in a situation where we have got high traditional input costs with I suspect softening of input costs as we move into the agricultural seasons. So you are going to have a combination of relatively high inflation in some input areas and relatively low inflation in some input areas and also the way you look at inflation perhaps we could take a relook at. The traditional way of looking at inflation in India at least is what is the consumer price index or the wholesale price index in April versus April last year. I think that's meaningless because what is more important is that in April the average prices were x, what is it going to be in May and June? If the inflationary trend continues even if by economic statistics compared to same period last year its grown by 8-9%, but in actual fact its compared to what it is today, it remains stable or coming down, inflation to the consumer is coming down. Therefore, if you are able to sustain an agri input level of prices fairly consistent with what they are today, I am not too worried. Q: If things improve in terms of input cost stabilizing a bit, if the expected growth on widening of the market continues as is most peoples expectation because the projections for economic growth are optimistic and if there are no major shocks to the economy from the external world or otherwise then you do hope to continue to achieve the 20-25% growth rate in non-cigarette FMCG businesses over the foreseeable future and you are on target to achieve breakeven for the entire category by FY12? A: Its pretty good, it seems to be we are on target. Q: You made the argument on both ends for volumes to come down and for volumes to go up. A: Absolutely. That's exactly what happens. India is unique remember that because we are only 15% in cigarettes you would have these increases and decreases. Q: You have also seen in the course of the last 12 months and I don't know if you have seen that in the course of the last month, which is when most state budgets came out, an increase in VAT in some of the states from 12.5% to 20% in some states. Have you seen a lot more states adopt that in the last month? A: Yes not just the last month the sort of budget season for the states actually is the whole of February and the whole of March. So between February and March several states have increased VAT not just on cigarettes but including general VAT increases. The 4% rate has become 5%, the 12.5% rates in some states have become 13% or 13.5% and so on so forth. Some states have made major changes, like for example, last year in July Maharashtra increased the rate of VAT on cell phones and on cigarettes from 12.5% to 20% and so on. Consequently what's happened is that it's not merely an excise increase it's an overall tax increase. And whether the money is going to the center or the states as far as the industry is concerned be it cigarette or otherwise it's an overall tax increase. Q: So if you were to combine both the impact of excise rates as well as the impact of increased state taxation-in the first half of the last financial year, which is FY10, you did a volume growth of roughly 6%, in the third quarter that you reported, you did a volume growth of roughly 8%. I am not asking you for a specific number but are you going to be able to sustain that over the course of this fiscal that we are in, which is FY11 counting both the impact of taxation but as well as the boost from economic growth? A: I am quite curious as to the numbers you are quoting because we don't report volume growth. However, the cigarette industry is going to decline this year. Q: It is going to decline? A: It probably is going to decline. But the question is-how quickly will it recover? What we have seen in the past is that the first few months see a decline and then as general economy improves that they start recovering. Will it recover from August-September? Will it start recovering from October-November? We will have to wait and see. That's difficult to say. That's in terms of volumes but in terms of how well the industry does in terms of overall consumption, remember, that if the industry declines by-argument sake-2% with tax rates having gone up by 18% to 20%, that means that industry has actually grown pretty considerably. Q: Will you pass on the price increase to all consumers based on the increase in tax? A: Let's put it this way-in the long run cost increases, will always be passed on to consumers. In the short run, pricing decisions are not based upon mere cost increases. Obliviously a very severe increase like an excise increase or VAT increase will require large a price increases but that already happened. Q: You have taken price increases in the last month? A: We have taken price increases ever since the budget came out. Enditem