Cigarette industry bracing for 6-8% volume contraction post additional excise duty levy: Crisil

New Delhi: The domestic cigarette industry is bracing for a 6-8 per cent volume contraction in the next fiscal, following the imposition of additional excise duties and an increase in GST rates from February 1, Crisil Ratings said on Wednesday.

Currently, cigarettes are charged 28 per cent goods and services tax (GST), along with a varied compensation cess.

From February 1, the compensation cess component will be removed, and an additional excise duty (ranging from Rs 2.05 to Rs 8.5 per stick) will be levied, based on the length of the cigarettes.

Crisil said mid to premium cigarettes (more than 65 mm length) will be levied excise duty of Rs 3.6-8.5 per stick, while cigarettes in the mass segment (less than 65 mm length) will be levied Rs 2.05 - 2.1 per stick. Additionally, the GST applicable on the final price will increase to 40 per cent.

Though the duty hikes are lower in the mass segment (accounting for 40-45 per cent of the volumes), the players are expected to partially absorb the same owing to the highly price-sensitive nature of this category.

Consequently, the earnings before interest and taxes (EBIT) margin is likely to see a 200-300 basis point decline but still remain healthy. This, coupled with robust liquidity of players and negligible debt, will help the companies sustain their credit profiles, Crisil said after an analysis of three major cigarette players, accounting for over 95 per cent of the organised industry volume.

Crisil Ratings Director Shounak Chakravarty said while the mid to premium segment will see higher duty hikes, amounting to 25 per cent of the current maximum retail price (MRP), manufacturers are expected to pass on the impact majorly to the end users, as consumers in this segment exhibit higher loyalty to specialised offerings, such as low nicotine variants and specialised flavours.

On the other hand, duty hikes in the price-sensitive mass segment will be lower at 15 per cent of the current MRP, and manufacturers are likely to partially absorb the same to minimise volume de-growth.

"That said, overall segment volumes might get impacted by 6-8 per cent next fiscal in line with the impact seen during earlier duty hikes," Chakravarty said.

Between fiscals 2014 and 2018, a string of duty hikes on cigarettes had resulted in a cumulative 40-50 per cent increase in their MRP, which, in turn, led to a 20 per cent volume decline. Manufacturers were able to recoup the lost volumes only over the ensuing 3-4 years, Crisil said.

Hence, this time, brands are expected to be more calibrated in passing on the entire duty hike, especially in the price-sensitive mass segment, it added.

While the overall impact of such price absorption on the industry’s EBIT (Earnings Before Interest and Taxes) margins will be restricted to 200-300 basis points, players having a higher share in the mass segment will feel a deeper pinch, Crisil said.

Nevertheless, EBIT margins are expected to remain strong at over 58 per cent next fiscal. Also, manufacturers have adequate financial flexibility for continued product innovation, aided by debt-free balance sheets and cash surplus of more than Rs 20,000 crore, Crisil added.