- ITC's cigarette business faces pressure from higher taxes with volume declines in Q2 FY27
- Analysts predict gradual cigarette profit recovery by Q4 FY27 amid price hikes and portfolio changes
- FMCG, paperboard, and agriculture segments showed strong growth, cushioning overall earnings
ITC's cigarette business remains under pressure from the sharp increase in taxation, but analysts see scope for a gradual recovery in profitability as the company adjusts prices and reshapes its portfolio.
The broad expectation, analysts believe, is that cigarette earnings could begin to recover by the fourth quarter of FY27 (Q4 FY27), although a sustained revival in volumes remains uncertain.
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This comes after ITC's Q2 FY27 results, which beat estimates by barest of margins, supported by strong performances in its FMCG, agriculture and paperboards businesses. Cigarettes, however, continued to weigh on earnings.
That said, foreign brokerages Jefferies and UBS have retained their ‘Buy' ratings, while JPMorgan and Goldman Sachs remain ‘Neutral'. Domestic brokerages Nuvama Institutional Equities upgraded the stock to ‘Buy' from ‘Hold', on the back of improving business momentum and attractive valuations. Emkay, meanwhile, retained its ‘Add' rating, even as it trimmed its target price.
Cigarette Business: Price Hikes Hold The Key To Recovery
The top concern across brokerage reports is the pressure on ITC's cigarette business following the unprecedented increase in taxes. Cigarette volumes declined 7-8% year-on-year (YoY) in the September quarter, while segment revenue and earnings before interest and tax (EBIT) fell 21% and 27%, respectively.
Jefferies expects calibrated price increases to support a recovery, while JPMorgan believes cigarette portfolio restructuring and further hikes could restore EBIT per stick by Q4FY27. UBS also expects profitability to improve by then, setting up a potential recovery in FY28. It flagged an upcoming price increase in the 69mm cigarette segment as a possible stock catalyst.
Goldman Sachs, however, expects the full impact of cigarette tax pass-through to be completed only by the end of FY27. It sees the double-digit decline in cigarette EBIT persisting in the second half.
Nuvama noted that the cigarette business showed an improvement sequentially, with net revenue and EBIT rising 5% and 14% quarter-on-quarter, respectively. This compares with declines of 1% and 39% in the June quarter. It expects cigarette EBIT to improve in the second half as the business adjusts to the higher tax regime.
The risk, as Emkay highlighted, is that the recovery in cigarette volumes could remain gradual. Uncertainty over the extent and timing of further price hikes, along with the upcoming Union Budget, could continue to weigh on the stock.
FMCG And Paperboards Provide An Earnings Cushion
The strength in ITC's non-cigarette businesses was a common positive in the brokerage commentary. FMCG revenue and profit before interest and tax grew 16% and 28%, respectively, in the September quarter. The segment also reported margin expansion of more than 50 basis points.
ITC said its FMCG revenue growth was at a 14-quarter high, with biscuits, snacks, noodles, spices, salt, frozen snacks, homecare and notebooks recording growth of more than 20%. Its digital-first and organic portfolio grew over 70%, with annual recurring revenue crossing Rs 1,800 crore.
The paperboards business also staged a strong recovery, with revenue and PBIT rising 36% and 48%, respectively. Agri business revenue grew 12%, while PBIT increased 11%.
Brokerages see these businesses providing support as the cigarette segment works through the tax shock. Jefferies, JPMorgan and UBS pointed to FMCG premiumisation, digital-first brands and improving paperboard demand as important growth drivers.
ITC Q2 Results: Profit Falls 20%, Revenue Edges Higher
ITC reported a 20.1% YoY decline in profit to Rs 4,137 crore for the September quarter, broadly in line with the estimate of Rs 4,129 crore. Revenue rose 1.8% to Rs 18,401 crore, ahead of the Rs 17,520 crore estimate.
At the operating front, earnings before interest, tax, depreciation and amortisation (EBITDA) declined 17.5% to Rs 5,160 crore, although it was slightly ahead of estimates.
Subsequently, the EBITDA margin contracted 660 basis points YoY to 28% in Q2FY27, from 34.6% a year ago.
According to ITC, its cigarette business was focused on a calibrated response to the tax increase, balancing the need to protect its consumer franchise against the risk of a disproportionate shift in volumes to illicit trade.
The company also highlighted a sharp increase in seizures of smuggled cigarette consignments, pointing to the widening tax arbitrage opportunity in the domestic market.
The key factor to watch out remains whether further price increases can repair cigarette profitability without accelerating the shift of consumers towards illicit products. Till then, strong FMCG and paperboard growth may cushion, but not fully offset, the pressure on ITC's largest profit pool.
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