ITC cigarette tax pass-through delays weigh on earnings despite FMCG margin improvement

Investment View and Key Thesis

Motilal Oswal Financial Services retained its Neutral rating on ITC. The broker's central concern is that ITC's calibrated, staggered cigarette price increases following the sharp tax increase are taking longer than expected to fully pass through to consumers. While this approach is intended to limit consumer migration to illicit cigarettes and protect the consumer franchise, it is expected to create near-term volatility in cigarette revenue and EBIT.

The broker retained its sum-of-the-parts target price of Rs 300, implying 18 times FY28E EPS, compared with the report CMP of Rs 281. Motilal Oswal expects cigarette earnings pressure to offset near-term benefits from FMCG margin improvement and paper recovery.

Q1 FY27 Financial Performance

ITC reported a weak consolidated Q1 FY27, with net revenue declining 11 per cent year on year to Rs 19,110 crore, below Motilal Oswal's estimate of Rs 21,900 crore. EBITDA fell 24 per cent year on year to Rs 5,180 crore, versus the broker's estimate of Rs 5,940 crore. Profit before tax and adjusted profit after tax declined 23 per cent and 22 per cent year on year, respectively. The quarterly miss was principally driven by the cigarette and agri businesses.

Cigarettes: Delayed Tax Pass-Through Weighs on Earnings

Consolidated cigarette net sales declined 22 per cent year on year to Rs 6,190 crore, broadly in line with the broker's estimate of Rs 6,170 crore, while standalone net revenue fell 25 per cent. Cigarette volume declined by high single digits. Consolidated cigarette EBIT dropped 32 per cent year on year to Rs 3,770 crore, below the Rs 4,110 crore estimate, while standalone cigarette EBIT fell 35 per cent.

Gross cigarette EBIT margin contracted to 22.7 per cent from 57.6 per cent in Q1 FY26. Management said that the GST increase from 28 per cent of transaction value to 40 per cent of retail sale price, alongside higher excise duties from February 1, 2026, materially raised cigarette tax incidence.

ITC implemented more than 30 portfolio interventions across brands, segments and price points, and used staggered pricing to limit downtrading to illicit trade. However, the slower pass-through of higher taxes is expected to keep cigarette revenue and profitability volatile in the near term.

FMCG-Others: Resilient Growth and Margin Improvement

FMCG-Others was comparatively resilient. Consolidated segment sales increased 15 per cent year on year to Rs 6,690 crore, in line with the Rs 6,670 crore estimate. Standalone FMCG revenue rose 12 per cent, or 16 per cent excluding staples.

Dairy, snacks, noodles and frozen snacks grew more than 20 per cent, while personal care recorded mid-teen growth. FMCG EBIT grew 22 per cent to Rs 490 crore, slightly below the Rs 520 crore estimate, and margin expanded 40 basis points year on year to 7.3 per cent.

ITC cited strategic inventory cover, commodity hedges, cost control, revenue management and price-volume balancing to mitigate inflation in fuel, edible oil, soap noodles and packaging. Digital-first and organic portfolio annual recurring revenue exceeded Rs 1,500 crore.

Agri and Paperboard Performance

Agri

The agri business was a material miss. Sales declined 16 per cent year on year to Rs 8,140 crore versus the estimate of Rs 10,790 crore, owing to West Asia conflict-related trade disruption and a high Q1 FY26 base. EBIT fell 17 per cent to Rs 360 crore and margin contracted to 4.4 per cent from 4.5 per cent, below the 6.5 per cent estimate.

Paperboard

Paperboard sales grew 9 per cent to Rs 2,310 crore. EBIT rose 43 per cent to Rs 220 crore and margin expanded 220 basis points to 9.4 per cent, supported by improved realisations and lower wood costs. However, the margin remained below the 12 per cent estimate.

Estimates and Valuation

Motilal Oswal cut its FY27E and FY28E EPS estimates by about 2 per cent. The revised estimates are as follows:

The broker retains its sum-of-the-parts target price of Rs 300, based on 18 times FY28E EPS. The report CMP is Rs 281.

Key Risks to the Thesis

• A slower or more disruptive cigarette tax pass-through.
• Sustained competition from illicit cigarettes.
• Volatile cigarette profitability.
• Trade disruption affecting agri operations.
• Input-cost inflation.