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CXO 1*1: Supratim Dutta, CFO

We launch a new report series on CXO 1x1. We met Supratim Dutta, ED & CFO, ITC. Takeaways: 1) Volume growth momentum in cigarettes is likely to continue driven by a stable tax environment and relative end price stability. 2) Premiumisation across segments driven by innovation and differentiation. 3) Growth in FMCG segment to be driven by fortifying core categories (Staples, Biscuits, Noodles, Snacks, Personal Care) while expanding into adjacencies. In smaller categories (Beverages, Chocolates etc.) that have expanded their salience in the portfolio over the last few years, the strategy is to drive growth in select regions with focus on unit economics. 4) ITC continues to aim for ~80- 100bps average annual margin expansion in FMCG. 5) On Electronic Nicotine Delivery System (ENDS), which is currently banned in India, policy stability is expected. Maintain ADD. 

Stable tax environment likely to continue (formal sector gains)

High taxation on cigarettes between FY13–FY18 (~15% CAGR) had led to an accelerated shift from legal cigarettes to illicit. Consequently, tax collections also turned sub-optimal, while the share of illicit cigarettes (in overall industry; India is the fourth-largest illicit cigarette market) increased from mid to high teens to >25%. Illicit cigarettes neither leads to tax revenue generation, nor compliance with tobacco regulations.

Post-FY18, the government has been focusing on curtailing illicit cigarettes (exponential increase in seizures) which has led to a relatively stable tax regime over the last 3-5 years. This has helped legal cigarette industry to partially claw back volumes from illicit trade. Though opportunities for price increases exists (given the overall inflationary environment), price increases have been moderate and, in our opinion, volume growth momentum is likely to continue given the relatively stable tax environment. We note that cigarettes volumes have not yet crossed the peak levels of FY13.

Premiumisation across segments driven by innovation and differentiation  

ITC is witnessing a trend of premiumisation from largely driven by holding on to the INR 10 price point in the segment under the Gold Flake franchise. As mentioned earlier, price increases have been moderate as ITC continues to focus on volume growth amidst relative tax stability (gains for formal sector). King Size Filter Tip (KSFT or 84mm) and Mini King Size Filter Tip (MKSFT or 74mm) segments continue to mirror overall growth with ~20% share in ITC’s Cigarettes business.

FMCG growth strategy

ITC plans to grow its FMCG business through four pillars: 1) Fortify the core (Staples, Biscuits, Noodles, Snacks, Personal Care). 2) Expand into adjacent spaces (e.g.: wheat and wheat derivatives with Aashirvaad, Premium dairy beverages with Dark Fantasy). 3) Grow the new core in categories such as Beverages, Chocolates, Confectionary and Dairy in chosen regions with a focus on the right unit economics. These categories have grown relatively larger (from <5% salience to ~7-8%). 4) Continue margin expansion of ~80-100bps annually on an average via improvement in logistics cost, premiumisation and scale benefits (certain gestating categories have reduced the profitability drag with increased size and scale). 

Regulations on ENDS unlikely to change in the near term

India enacted the Prohibition of Electronic Cigarettes Act, 2019 which banned a broad category of ENDS (Electronic Nicotine Delivery System) including electronic cigarettes, vaping devices, and Heat Not Burn (HNB) products. The government justified the ban on the basis of certain risks, including their potential impact on health, ability to attract youth, and concern that ENDS would undermine tobacco control efforts. Further, in May’23, the central government issued a public notice (as per media reports - link) for stricter implementation of the Act. These was triggered by easy availability of these products in tobacco shops, general stores, online providers etc. and their sale to children below 18 years of age

ITC had forayed into electronic cigarettes in 2014 with launch of two electronic-vaping devices, or electronic cigarettes, under ‘Eon’ brand. The product was not very successful due to higher cost per puff vs conventional cigarettes before the category was banned by the Government of India. However, ITC’s 100+ years of experience in tobacco industry along with its distribution reach will likely be key to manage such disruptions (if any). Before ENDS was banned in India, ITC had initiated appropriate investments, enhancing capacity and was gearing up to be in a state of readiness in this emerging segment. Another aspect that the government is likely to consider would be the impact on tobacco farmers and taxation on these products. ENDS uses reconstituted tobacco which is a global technology which reduces use of leaf tobacco in these products which could likely impact income of tobacco farmers in India.

Valuation and risks

 Our earnings estimates are unchanged. Maintain ADD with a DCF-based unchanged target price of INR 500. At our target price, the stock will trade at 26x P/E multiple Mar’25E. Key downside risk is tax hikes materially ahead of inflation leading to lower volume growth (on cigarettes) as price elasticity turns unfavourable

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