Higher excise duty and GST changes from 1 February may dent demand, though industry margins are expected to remain resilient.
India’s cigarette makers are preparing for a demand slowdown next financial year, with volumes projected to fall 6–8 per cent after fresh tax changes take effect from 1 February, according to Crisil Ratings. At present, cigarettes attract 28 per cent GST along with a variable compensation cess. Under the revised structure, the compensation cess will be scrapped and replaced with a length-based additional excise duty of Rs 2.05 to Rs 8.5 per stick. At the same time, the effective GST on the final retail price will rise to 40 per cent.
Crisil said the steepest duty increases will apply to mid- and premium-category cigarettes measuring over 65 mm, which will face an excise levy of Rs 3.6–8.5 per stick. Shorter cigarettes in the mass segment will attract a lower duty of Rs 2.05–2.1 per stick.
Although the absolute tax hike is smaller for mass-market products, which account for 40–45 per cent of industry volumes, companies are likely to absorb part of the increase because of the sharp price sensitivity of consumers in this segment. As a result, operating profitability is expected to narrow modestly.
Crisil estimates earnings before interest and taxes (ebit) margins could decline by 200–300 basis points. Even so, margins are expected to stay robust, supported by strong cash flows and minimal leverage across leading players. The agency’s assessment covered three large cigarette manufacturers that together contribute over 95 per cent of organised industry volumes.
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.
Crisil pointed to the experience between fiscals 2014 and 2018, when successive tax increases drove cigarette MRPs up by a cumulative 40–50 per cent, triggering a 20 per cent drop in volumes. It took manufacturers about three to four years to regain those volumes.
Given that backdrop, companies are expected to be more measured this time in passing on the full burden of higher duties, especially in the mass segment where demand is more vulnerable.
Even with some price absorption, the hit to industry ebit margins is seen as limited to 200–300 basis points. However, firms with greater exposure to lower-priced cigarettes could face relatively higher pressure on profitability.
Still, overall ebit margins are forecast to remain strong at above 58 per cent next fiscal. Crisil added that the sector retains significant financial headroom for product development and innovation, backed by debt-free balance sheets and cash reserves exceeding Rs 20,000 crore.
