ITC: How Inelastic is Cigarette Demand?

Source from:  livemint.com  05/29/2014

The cigarettes industry has borne the full brunt of the government's attempt to raise revenues. In an economic slowdown, the industry became a soft target, with two successive years of sharp hikes in excise duty. The cumulative impact has been significant. ITC Ltd, the market leader, has seen volume growth decline in 2013-14, a rare event in a sector where demand is not supposed to be affected by prices.

ITC has raised prices of cigarettes by about 17% in 2013-14 to compensate for slower growth and higher taxes. At least some consumers have shifted out. The company also blames illegal trade in cigarettes for eating into the organized market's sales. In the March quarter, volumes are expected to have declined by 2-3%.

Still, ITC's price hikes have been absorbed by the vast bulk of its consumers. The company has also promoted cigarettes of smaller length that attract lower excise duty. Thus, sales growth has risen by 12.6% in the March quarter over the year-ago period, but segment profit has risen by 20.8%. ITC's pricing power may be hurting its cigarette segment's sales growth, but profitability continues to chug along just fine.

But low sales growth is a worry. There was a time when its consumer business—comprising foods and personal care products—provided that zing to sales growth. Investors were hoping that this business will begin making profits. That it has, but it has been accompanied by slower sales growth.

Thus, the consumer business sales growth in the March quarter was 13.7% compared with 16.6% in the previous quarter. But it also turned in a profit of Rs.43.1 crore compared with Rs.10.4 crore in the preceding quarter. In 2013-14, the business earned a profit of Rs.21.8 crore, compared with a loss of Rs.81.3 crore. But sales growth has slowed down to 15.9%, compared with 26% in the previous year. It raises a question on whether profitability will decline once the company shifts the focus back to sales growth.

Under the circumstances, ITC's earnings growth continues to hinge on cigarettes, which has shown remarkable resilience in difficult years. But the strain is showing on sales growth. The first signal that the company's fortunes are changing for the better will come if the new government lights the peace pipe by holding excise duties at the current level in the forthcoming budget. Enditem