Concerns over valuations, cigarette volumes weigh on ITC

ITC’s June quarter numbers were slightly ahead of Street expectations. Higher-than-expected cigarette volume growth of about one per cent against expectations of a two per cent decline, expansion in margins and good performance of the consumer goods, agricultural and paper businesses helped ITC post robust results. However, the stock fell two per cent to close at Rs 249.45 on Thursday, as against the Sensex’s fall of 0.2 per cent.

Though ITC is expected to post a strong performance this financial year as well, some analysts are worried over the growth in cigarette volumes in 2012-13. Analysts are also divided in terms of stock valuations, which are not cheap at current levels. At nearly 30 times FY13 estimated earnings, the stock is trading at the higher end of its one-year forward price/earnings band of 18-30 times seen in the past five years. It has been seen in the past five years that whenever the stock’s one-year forward PE comes close to the higher band, it tends to underperform/fall thereafter for a couple of months.

However, the current weak macro environment could continue to play in its favour (read: demand for defensives), at least till the ‘risk on’ sentiment gains. V Srinivasan, research analyst at Angel Broking, says, “ITC posted healthy sales and net profit growth. We continue to remain neutral on the stock, as we believe it is fairly priced at current levels.” On the other hand, analysts at Morgan Stanley Research wrote in a post-results note, “ITC results were overall in line with expectations. We reiterate our overweight rating on ITC, given unparalleled visibility for earnings growth, which will likely continue to support valuations, we believe.”

 The difference on valuations perhaps also stems from the fact that analysts are divided on cigarette volume growth, wherein estimates vary between minus three to plus three per cent for FY13. That’s because some believe ITC would raise prices to the extent that it fully passes on the cost increases seen, while others believe partial hikes will be taken. Data from the past 15 years (as compiled by IIFL Research) shows a strong inverse correlation between price increases and ITC’s cigarette volumes. When price rises are in excess of seven per cent, volume growth in the cigarette business tends to be muted and vice versa.

In FY13 so far, analysts say, ITC has already taken a price rise of about 15 per cent, led by an increase in taxes, and some more is in the offing. The silver lining could be the entry of ITC in the sub-65 mm segment. ITC is already testing its products in 64-mm cigarettes in UP and Bihar. Analysts believe this segment could provide support to volumes to the extent of one to two per cent, even as they are monitoring the situation, given the price differential with unorganised cigarettes. Beyond cigarettes, which account for over 80 per cent of ITC’s profits, the break-even of the other fast-moving consumer goods (FMCG) business would act as a key trigger to earnings growth. Also, pick up in its hotels business will remain a key monitorable.

Cigarette manufacturers: FBR accused of introducing complicated FED system

The Federal Board of Revenue (FBR) has introduced a very complex 'slabs system' of the Federal Excise Duty (FED) for the cigarette manufacturers which has only benefited the multinational companies with stagnation in the incidence of taxes ie sales tax/FED on most popular brands of the product. Tax experts told Business Recorder here on Thursday that the multinational companies and the FBR had deliberately implemented a very complicated excise duty system to charge less amount of FED on popular brands of cigarettes. The existing taxation system of the FED is so complicated which only give maximum benefit to the cigarette manufactures.

Prior to budget (2012-2013), World Health Organisation (WHO) has recommended that the FBR should abolish the existing FED charged on the basis of threshold and slabs of the FED for different brands of cigarettes. All brands be treated at par instead of tier system, there should be one system which ensure revenue for the government, help FBR in ensuing compliance and easy to comprehend by all stakeholders. Due to unknown reasons, the FBR fully endorsed the complicated excise regime which facilitates the leading multinational companies.

Tax officials and the cigarette manufacturers have made the excise duty structure in such a manner that ordinary consumer would be totally confused while understating the techniques used for imposition of the excise duty on cigarettes. One of the reasons for implementing a confusing tax system for cigarettes is that some of retired bureaucrats have been hired by multinational companies having connection in government circles and policy makers. Recently, it has been reported that the foreign companies have transferred an amount of over $1 billion aboard on account of profit and dividend during the last fiscal (2011-12).

The repatriation of profit and dividend by foreign companies is again on rise and they are repeatedly transferring their profits and dividends. The foreign investors have repatriated nearly $1.061 billion on account of profit and dividend in fiscal 2012 against $758.3 million in fiscal 2011, depicting an increase of $303 million. On the other hand, multinational companies in the tobacco sector are using different techniques to ensure minimum increase in incidence of taxes on cigarettes. When contacted, a tax official, who have done research on cigarette industry, explained that firstly the existing tax structure should be simple. The present tax structure is complicated and favors to the multinational companies. The incidence of taxes on lower brands should be higher as compared to existing structure.

 The incidence of sales tax and federal excise duty on cigarette has not been increased at par with the globally applicable tax rates on popular brands. Globally, there is a standard that the incidence of tax on cigarettes should be at least 70 percent as the cost of production of this commodity is very low. The incidence of sales tax and FED on the strong brands of cigarette could be termed as stagnant in Pakistan as compared to other countries where incidence of taxes goes up to 70 percent. In Pakistan, if the incidence of sales tax/FED was 42 percent on a specified brand, it has been increased to 45 percent and then 52 percent on annual basis.

However, even the incidence of sales tax/FED has been taken up to 60 percent it is still very low as compared to the 70 percent. The technique used by the multinational companies is to re-adjust the middle slabs with upward adjustment in price. In this way, the incidence of the sales tax and the FED has not been increased, but the price has been increased for popular brands to ensure that the incidence of taxes should remain on the lower side. "Resultantly, the FED has been increased in terms of rupees, but in term of percentage, the incidence of the FED did not increase. Apparently, the excise duty has been increase due to increase in price of cigarettes, whereas the incidence in actual terms of percentage has not proportionately increased, he added.

 If the incidence of taxes is 70 percent on a specific brand, the technique is to ensure incidence of tax of 50 percent or 60 percent on most popular brands. If the market is captured by two popular brands, their actual incidence of taxes would not be increased at par with the global prevailing rates of taxes. This has been done by increasing prices linking with the FED, but the direct incidence of taxes has not increased. Official said that the multinational companies have also adopted another technique to discourage introduction of new brands by local units of Mardan etc. This has been done by fixing a minimum price for launching of a new brand. A new brand cannot be launched unless of until a specific price has been fixed which discourages local units to introduce new brands.

Cigarette seizures quadrupled over two years

Maryland's seizures of contraband tobacco quadrupled between 2010 and 2012, Comptroller Peter Franchot said Wednesday, attributing the increase in part to lax penalties that fail to deter cigarette smugglers from a highly profitable enterprise. Flanked by piles of confiscated tobacco and alcohol products, Franchot announced that his field enforcement agents and other police agencies had seized 325,851 packs of illegally trafficked cigarettes valued at $2 million in the 12 months that ended June 30. The confiscations represent a near-doubling of the previous year's total of 184,498 and are more than four times the total posted in the fiscal year that ended June 30, 2010.

 Franchot credited the increase in part to stepped-up partnerships between his office's enforcement arm and other law enforcement agencies. But he added that the numbers also reflect the money that smugglers can make by transporting cigarettes from low-tax states such as Virginia, where the tax per pack is 30 cents, to Maryland, where the state adds $2 to that cost. The comptroller used the announcement to call on the General Assembly to pass legislation to "dramatically" increase the penalties for smuggling or possessing untaxed tobacco products in Maryland.

 "Criminals are going to repeat this action," Franchot said. "It is too lucrative and the penalties are too small." The Comptroller's office pointed to the case of Stepfon Leroy Wilkins, 49, and Chaniqua R. Rhodes, 40, of Bronx, N.Y., who were arrested on charges of transporting unstamped cigarettes March 5 and April 2 in Princess Anne and again June 4 in Harford County. Charges were dropped in the first case but are pending in the other two. According to the comptroller's office, Franchot proposed legislation during this year's General Assembly session that would have increased the fines for transporting unstamped cigarettes from $50 a carton to a mandatory $150 per carton on the first offense and a mandatory $300 on subsequent offenses.

The bill would have left the maximum jail term for a first offense at two years but increased the limit for subsequent offenses to five years. The legislation passed the House of Delegates 115-12 but stalled in the Senate without a committee vote. Franchot said the legislation "got caught up in politics" in the Senate and was held down "from on top." He declined to say whether he was referring to Senate President Thomas V. Mike Miller, with whom he has long had a contentious relationship. The comptroller vowed to renew his effort to pass the legislation during next year's session. Earl Fowlkes, assistant director of the comptroller's field enforcement division, acknowledged that many cartons of tobacco are sold illegally for every one seized.

 "I would be hesitant to even guess what really gets through or what is sold here in Maryland," he said. "I do believe we are only touching the tip of the iceberg." In addition to announcing the increase in cigarette seizures, Franchot said his office had confiscated $92,000 worth of illegal alcoholic beverages during the year ended June 30 compared with just over $50,000 the year before. Contraband liquor and tobacco is held as evidence as long as needed and then can be sold to license holders at auction. The exception is beer, which is destroyed rather than sold because of its limited shelf life.

WHO urges Philippine senate to block tobacco lobby

The World Health Organization is urging Philippine senators to pass a bill that would jack up cigarette taxes to discourage smoking and raise revenues for universal health care. It says the lawmakers should resist lobbying by the tobacco industry against the bill.

Dr. Soe Nyunt-U said Friday that raising taxes on cigarettes is the "most powerful policy tool" to reduce tobacco use. He said the tobacco industry should not be consulted on public health issues. Philippine Health Undersecretary Paulyn Jean Ubial said 17.3 million Filipinos smoke, about three out of 10 adults.

That is one of Southeast Asia's highest prevalence rates. She says 87,000 Filipinos die yearly of tobacco-related diseases. Chris Nelson, president of PMFTC Inc., which controls over 90 percent of the Philippine cigarette market, was unavailable for comment.

P165-M alternative livelihood project targets tobacco farmers

NTA said the project entails building an AgriPinoy Tobacco Farmers Food Processing and Trading Center in Barangay Nanguneg, Narvacan, Ilocos Sur, as well as a contract growing scheme involving hogs and poultry wherein the government will provide production inputs. “The trading center shall buy and process meat into best-selling products like bagnet, Vigan longaniza, tapa, bacon, barbecue, and similar products for sale in food terminals, groceries, markets, hospitals and offices in Region I, CAR (Cordillera Administrative Region) and Metro Manila,” the agency explained.

NTA will also train tobacco farmers in hog fattening and broiler growing and will provide other forms of technical assistance, including monitoring and supervision. NTA Administrator Edgardo D. Zaragoza said the project is part of his agency’s comprehensive assistance scheme for small tobacco farmers. “It shall also provide an alternative marketing system and business model to increase tobacco farmers’ purchasing and bargaining power, and develop farmers’ capabilities to manage dynamic rural enterprises,” he added.

Mr. Zaragoza said NTA expects the tobacco farming sector of beneficiary areas to earn additional income of up to P8 million in the center’s first year of operations. “This is projected to increase to P 10. 4 million in the second year, P13.6 million in the third year, P17.8 million in the fourth year, and P23.3 million in the fifth year of operation,” he said. The project will serve the whole Ilocos region, as well as Abra, La Union and Pangasinan.

NTA said it plans to expand the initiative’s coverage to other major tobacco growing provinces in the Cagayan Valley. “Considering that [it caters] to basic needs and that food accounts for 46.91% of the personal consumption expenditures of average Filipino families, the [project] will have a sure pre-arranged market, not only locally, but in the future, on a global scale,” said Mr. Zaragoza.

State Regents urge universities, colleges to ban tobacco on campus

The Ohio Board of Regents finalized a resolution July 23 urging the state's colleges and universities to adopt tobacco-free policies on their campuses, which could mean no smoking, chewing or otherwise consuming related products in dormitories, outdoor spaces or any other areas. The resolution, OK'd on a unanimous vote, is symbolic rather than policy setting. The regents have no authority to implement such plans; college and university boards of trustees have to develop and finalize their own tobacco- or smoke-free policies.

But Regents Chairman James Tuschman said he hopes the resolution will mark the start of discussions and debates on individual campuses and the eventual adoption of tobacco prohibitions at the state's 14 four-year universities, two dozen regional campuses, 23 community colleges, the Northeast Ohio Medical University and other higher education locations. "What we're trying to do is modify behavior," Tuschman said.

"This is the way we think is the way to do that. Will we succeed in every respect? I don't know. It's going to be very interesting... how these campuses debate and consider this. They're going to get input from their students, their faculty. There's going to be very serious discussion about this. Our job here is to raise the issues, is to bring forward what we think is a leadership position." Smoking already is banned in many university campus buildings, thanks to the constitutional amendment OK'd by voters several years ago that prohibited smoking in public places. But Smoke Free Ohio law does not cover dorm rooms or open spaces on campuses.

More than half a dozen colleges and universities in the state, including Malone College and Miami University, have implemented extended smoking or tobacco prohibitions to cover such areas. According to statistics released by the regents board July 23, close to 800 campuses nationwide have instituted smoke-free policies. Backers say the bans are needed to make campuses healthier, thus cutting down on future medical costs, and to reduce the number of young people who become regular smokers during their early years in college. They also would like campuses to provide cessation counseling at no cost to employees. "...

Ohio would be far better off if our public universities and community colleges were smoke-free locations," said Chancellor Jim Petro, himself a smoker for 40 years who attributes the habit to the laryngeal cancer that has left him with a raspy voice. A representative of Cleveland Clinic, which supports tobacco-free policies, urged the regents to consider supporting stricter policies against tobacco use, including blocking the hiring smokers or firing employees who refuse to quit. And Regent Patricia Ackerman, who stopped smoking after 36 years, questioned whether Ohio colleges and universities should be prompted to pursue a common date on which they would all implement tobacco bans. "I would hate for us to make a recommendation and leave it to chance on the implementation side," she said.

Minn. raid nets suspected synthetic marijuana

Authorities have seized 20,000 packets of suspected synthetic marijuana from a Duluth head shop as part of a nationwide crackdown. The U.S. Drug Enforcement Administration says Wednesday's raid on the Last Place on Earth also netted two assault rifles, three handguns and cash estimated at about $20,000. Authorities also seized about $2.8 million from the store owner's bank accounts and two vehicles.

Three customers were arrested on outstanding warrants not related to the investigation. Close to two dozen officers participated. Police also raided the Last Place on Earth last September. Calls left for store owner Jim Carlson and his attorney were not returned Thursday. Nationwide, the DEA seized more than $36 million in cash and arrested 91 people in a crackdown against manufacturers, distributors and vendors of synthetic designer drugs.