>ITC: Gold Flake Kings sets the direction of potential price increases in the near term

What’s new: ITC ended last year with a 70 paisa per stick price hike on Gold Flake (GF)
Kings cigarettes (c10% of overall volume). This move will add c1.5% additional EPS for fullyear FY12, with overall volume remaining unchanged. The hike was not surprising as ITC
continues to shape the price of its overall cigarette portfolio to manage the positioning and
price points of its various brands and prepare for punitive taxation the sector is subjected to.
What should we read from this price hike?


What to expect: This price hike in our view creates the cushion and sets the direction of price
increases in the near term. With this change, ITC Classic (INR5.50 per stick), which has a
relatively premium positioning, is the same price as GF Kings. In our view, Classic’s price can
be tweaked upward, should the situation require ITC to do so. Classic and GF Kings are part of the volume mix (c20% of total volume) that is relatively price inelastic and we observe that
consumers of these cigarettes have ‘sticky’ preferences; hence we see limited volume risk.
Nearly three-quarters of ITC’s cigarette volume comes from the lower priced regular segment
(e.g., GF Regular, Navy Cut) and the direction of price increases in this segment will be
relatively more cautious.


Earnings and taxation: Future tax increases on the cigarette business are a common concern. We model c12% excise hike affecting FY13, and in our assessment this single price hike in GF Kings and an additional increase of 50 paisa per stick of ITC Classic can nearly offset the impact of this excise duty hike assumption. We estimate there will still be room for 5-7% hikes across 75% of cigarette volume. We increase our earnings estimate by 1.5% for FY12 to reflect this price hike, but keep FY13-14 earnings almost unchanged as ITC on balance should increase prices selectively and just enough to negate the impact of additional taxation. 


Valuation and risks: With risk aversion on the rise, we see ITC at 22x FY13x PE as
attractively valued. Its defensive business and FY11-15e earnings CAGR of 16% will likely
help it outperform the peer group on the next one-year perspective. We maintain our SOTPbased target price of INR242 and reiterate our Overweight rating. Key downside risks are slower than anticipated progress or loss of market share in growing categories in other FMCG and ITC’s stock price’s sensitivity to excessive taxation shocks.


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