ITC gaining on hopes of measured duty hike

ET Intelligence Group: Buoyed by expectations that excise duty increase in the Budget would be rational and less than aggressive, ITC shares have risen more than 13% in the past one month hitting a new high of 401.9 last week. The stock typically trades on weak sentiment ahead of the Budget in anticipation of an increase in excise duty . It has been one of the worst-performing FMCG stocks in 2014, under pressure from regulatory overhang. So, what's different this time?

There is a strong case for the government going ahead with a measured in crease in excise duty in this Budget.

Between 1997 and 2010, increase in excise duty has been 200 bps higher than inflation. But since 2011, the duty has increased at a compound annual growth rate of 13%, higher than inflation. For the first time in the December 2014 quarter, this resulted in a decline in the excise duty collections from the cigarette industry.

Excise collection from the cigarette industry is important for central government finances. However, the cigarette excise collected by the government has averaged at 2.2% of the overall tax collections. This share has dropped from 3.4% in 1999 to 1.3% in 2014.

Recent VAT reductions by state govern ments also hint at a rational duty increase. Rajasthan, which had highest tax rate at 65% (ad-valorem), has moved to a specific rate of 25%. Madhya Pradesh reduced VAT from 27% to 14%, Uttar Pradesh from 50% to 25%, Bihar from 30% to 20%, and Punjab from 55% to 30%.

Steep duty increases have prompted ITC to aggressively raise price by 17-18% annually in the past three years. This has impacted volumes this year. Analysts expect ITC's FY15 volume to end at a level lower than that in fiscal 2007.

Analysts are expecting an excise duty increase in the range of 5%-10%. While an increase below 10% could lead to rerating of the stock, anything above 10% will be negative.