Budget 2020: Impact of budget proposals on tobacco stocks

As expected, union budget 2020 has increased duty on cigarettes of various lengths. If you are a smoker, then you will have to pay more and you are hurting your health. If you are an investor, you are hurting your wealth.

Cigarettes were taxed earlier by the GST Council and the Centre has put National Calamity Contingent Duty (NCCD), but this time around from Rs 5 per 1,000 sticks across various length the duty has been increased to Rs 440 for cigarettes which are between 65-70 mm, and at scale, it fixes because Rs 5 per 1,000 sticks is just about 1 paisa for two sticks. Rs 440 per 1,000 sticks is 44 paisa per cigarette.

Those who smoke the more expensive Rs 15 cigarette, they will have to shell 75 paise more out. What does this mean for the price of your cigarette for a smoker and the cost of the cigarette for a company that manufactures a cigarette? A rough calculation suggests that the companies will have an increase of nearly 6-8 percent of tax per cigarette stick that means that they will have to increase the price per cigarette by around 50 or 70 paise per stick.

If the companies decide that maybe volumes may not grow if they increase the price and they take the hit on their operational performance, then there could be an EBIT hit of anywhere between 11-13 percent. That means the net profit would be impacted by much more and there could be further de-ratings for the stock which is exactly why we saw the decline that we did in the shares of ITC, Godfrey Phillips as well as VST Industries.

The bigger fear is that this Rs 5 per 1,000 sticks was a basic excise duty that the government added in budget 2019 to fill a legal loophole as you cannot levy NCCD if there is no excise duty, so this is something that the street was okay with. But then they had a fear that now that this duty has been levied, there would be an increase in subsequent budgets and that is exactly what happened.

So going forward not only will the Street will be worried about every GST council meeting where there is always a fear of the cess being increased on the tobacco, there will always be a fear of a budget for all these tobacco companies and that is for the Centre. Does this happen with states or not, the jury is still out on that and we have already seen a couple of downgrades coming by on the tobacco stocks.