Cigarette companies: promise higher prices with higher volume

Shares of cigarette companies have fallen over the past month, with three leading cigarette makers ITC, Godfrey Philips and VST Industries hitting record highs. All three stocks have posted strong returns over the past one year, significantly outperforming the benchmark Sensex, helped by favorable tax and cost-competitive increases in tobacco products.

Unlike previous years, the central government did not increase excise duty on cigarettes in this year’s budget, although states have increased the value-added tax (VAT) to varying degrees. While northern states like Rajasthan have raised the VAT on cigarettes significantly, all southern states have spared the sector from the big hike. In contrast, tobacco products such as pan masala and chewing tobacco are witnessing an increase in costs due to higher taxes and increase in the cost of raw materials.

Also, tobacco prices have remained soft compared to the high prices of ‘Tandu’ leaves used in making ‘Badis’. The cigarette industry has been encouraging bidi smokers to buy cheap cigarettes by pricing low-end and microfilter cigarettes in competition with bidi prices. Also, contrary to its previous plans, the government decided to issue less attractive pictorial warnings on cigarette packs, which helped sentiment in stocks.
In the quarter ended June, VST Industries reported a 90% year-on-year increase in net profit. ITC, which is yet to announce its first quarter earnings, is expected to witness a rise in cigarette volumes despite price hikes in some products. Going forward, the rally in cigarette companies is likely to continue as all factors look positive for the sector.
Analysts expect cigarette companies to report strong earnings growth driven by higher volumes, higher prices and lower costs.