ITC’s third-quarter fiscal 2016 sales were up 3% year over year, and earnings were flat, below our respective estimates of 6% and 2%. Cigarette revenue growth was modestly ahead at 6%, versus our expectation of 5% for 2016.
The third quarter tends to be seasonally strong for the company; however, persistent increases in excise duties continue to weigh down branded cigarette volumes for the whole industry. While other listed Indian competitors like Godfrey Philips and VST Industries are yet to report their third-quarter numbers, both suffered declining cigarette sales in the first six months of fiscal 2016. We maintain our 2016 forecast and our fair value estimate of INR 406 per share on this narrow-moat stock.
Our fair value estimate factors in a long-term growth forecast for cigarettes of 12% between 2017 and 2020, compared with 14% growth between 2010 and 2014. Between 2014 and 2016, cigarette taxes increased by close to 100%, putting severe pressure on branded cigarette sales for the entire industry. The share of legal, branded cigarettes has declined to 11% of total tobacco consumed in 2015, versus 12% in 2014 and 21% in 1982.
Looking on the bright side, India remains a market with growing overall cigarette sales, versus declining sales in most developed countries. Cigarette taxes, however, are currently highly punitive in India; this is a major headwind faced by ITC’s near-monopoly business, which contributes nearly 80% to India’s branded cigarette sales. Keeping this in mind, if further excise hikes continue, we may consider cutting our cigarette growth forecast, which will have a material impact on our fair value estimate.
A cut in our forecast for cigarette sales growth between 2017 and 2020 to 6%, from 12% presently, would reduce our fair value estimate by 15% to INR 347 per share. The stock continues to trade 10% below this value and 23% below our INR 406 per share fair value estimate, and continues to look attractive from our perspective.
