After declining 13-15% last fiscal, cigarette sales volume is set to rise 7-9% to 83-85 billion sticks this fiscal, driven by recovery in out-of-home consumption, limited price hikes and a lower-base effect.

But that won’t be enough to lift the volume to pre-pandemic levels of ~90 billion sticks seen in fiscal 2020, as the second wave of Covid-19 infections has moderated demand recovery. That is because the hotel, restaurant and cafe (Horeca) and workplace segments, which drive out-of-home consumption, are unlikely to recover to pre-pandemic levels in current fiscal.

Nevertheless, higher revenues and volumes, healthy operating profitability and strong balance sheets will ensure healthy credit profiles of cigarette manufacturers, shows an analysis of four CRISIL-rated ones accounting for ~90% of the industry’s volume.

The ~Rs 25,000 crore organised domestic cigarette sector comprises premium king-sized (84 mm and longer) and regular (69 mm) and mini (64 mm and below) segments. Before the pandemic, the regular and mini segments contributed ~40% and ~43%, respectively, while the premium segment contributed ~17% to the overall volume. However, the pandemic had a greater impact on volumes of premium king-sized cigarettes, likely owing to down-trading caused by affected income levels and higher prices resulting from steep excise duty hikes in the Union Budget 2020.

The overall impact on sales volume this fiscal would be less severe because personal mobility and manufacturing and distribution activities have not been as affected as in the first wave. Additionally, with no hike in taxes on cigarettes in the Union Budget for this fiscal, prices are unchanged, which should support volume recovery, and drive revenue growth.

Last fiscal, volume was hit in the first half due to the lockdowns, which also curbed socialising. Closure of offices and curbs on manpower at workplaces for most of last fiscal hit consumption the hardest. Despite this, revenue de-grew only 5-7% because manufacturers passed on most of the ~13% hike in excise duty introduced in Union Budget 2020.

Says Gautam Shahi, Director, CRISIL Ratings, “Overall cigarette sales volume rebounded strongly to ~95% of the pre-pandemic level in the fourth quarter of last fiscal due to a return to near-normal situation. Then came the second wave, which is estimated to have reduced sales volume sequentially by ~10% in the first quarter of this fiscal. Despite this, volume should end up higher this fiscal (on-year), with workplace, retail and recreation mobility already improving to 63% of the pre-pandemic level¹ in April-July versus 44%² in the same period last fiscal.”

Domestic cigarette manufacturers enjoy strong operating margins of ~40%³, resulting in strong cash flows. Therefore, despite moderately lower revenues and lower contribution from the premium segment, cost-cutting initiatives have limited the decline in margins last fiscal. As revenues improve this fiscal, operating margins are likely to be stable despite better operating leverage, as expenditure on promotions would spring back to pre-pandemic levels.

Says Kiran Kavala, Associate Director, CRISIL Ratings, “Credit profiles have shown high resilience, given healthy cash generation derived from robust profitability. Also, capex spends have been modest, leading to strong balance sheets, and robust liquid surplus (~Rs. 20,000 crore as on March 31, 2021). The ‘Stable’ outlook for credit profiles of cigarette manufacturers is expected to be sustained due to these intrinsic strengths.

The key monitorables in the road ahead are fresh waves of Covid-19 impacting demand and supply for the remainder of this fiscal, stability of tax regime, and regulations around tobacco consumption.

¹ Mobility observed during the 5-week period between January 3 and February 6, 2020.
² Mobility data source: Google mobility reports
³ Simple average of operating margins (earnings before interest and tax) of rated players