Increased outdoor mobility and a stable tax regime will light up cigarette sales volume by 5-6% on-year this fiscal, helping it surpass pre-pandemic levels. At an expected sales of ~93 billion sticks, the organised cigarette industry volume will be 3% higher than in fiscal 2020.

But rising input prices will shave 100-150 basis points (bps) off the gross margin of manufacturers. Credit profiles, however, will remain healthy owing to higher volumes, healthy operating margins, and strong balance sheets, an analysis of cigarette manufacturers rated by CRISIL Ratings, which account for over 90% of organised sector volume, shows.

Says Anand Kulkarni, Director, CRISIL Ratings, “The cigarette sales volume run rate exceeded pre-pandemic levels in the fourth quarter of last fiscal as the impact of the third wave turned out to be modest. Increasing occupancy at workplaces, near-normal retail and recreation mobility, and a stable tax regime over the past two years augur well for demand.”

In fiscal 2021, these three mobility indicators remained below pre-pandemic levels, as reflected in a 14% decline in cigarette sales volume. But last fiscal, volume surged 14% as the indicators improved to near-normal levels (see chart 2 in annexure).

Taxation also has a sizeable bearing on demand for cigarettes. Since fiscal 2013, such levies — including excise duty and Goods and Services Tax (GST)¹ — have increased significantly. This has seemingly led to progressive migration from duty-paid cigarettes to other lightly taxed/ tax-evaded tobacco products such as illegal cigarettes and bidi. But with taxes stabilising over the past two fiscals, demand for duty-paid cigarettes improved to some extent.

However, profitability of cigarette makers is likely to marginally decline this fiscal because prices of tobacco and packaging, which together account for 50-60% of total cost, are rising.

Cigarette makers largely use flue-cured Virginia (FCV) tobacco, prices of which have been volatile. FCV prices have surged ~15% on-year as cultivation was impacted by untimely rainfall in December 2021 and January 2022², which is the typical harvesting period. Prices of paper (key component of packaging) are estimated to be 10% higher this fiscal on an already elevated base of last fiscal. Further, post the ban on single use plastic, the outer packaging of cigarette will need to shift to biodegradable materials, which will also increase cost to some extent. These are expected to impact the gross margins of domestic cigarette makers.

Says Gopikishan Dongra, Associate Director, CRISIL Ratings, “Nevertheless, profitability will remain healthy this fiscal, with EBIT margin at ~65%, due to the strong competitive advantage of established manufacturers and high entry barriers such as entrenched distribution channels and restrictions on advertising. The credit profiles of cigarette makers have been resilient given healthy cash generation. They also have strong balance sheets with negligible debt and robust liquidity of ~Rs 30,000 crore as on March 31, 2022.”

Though Covid-19 cases are slowly rising, our base case does not assume a significant impact of resurgence in infections. Stability of the tax regime and regulations on tobacco consumption also bear watching.

¹ During fiscals 2013-17, excise duty on cigarettes logged a CAGR of 15.7%. In fiscal 2018, the legal cigarette industry saw further rise of 20% in tax incidence as a result of increase in excise duty and transition to the GST regime.
² FCV tobacco is grown in Andhra Pradesh, Telangana and Karnataka. It is harvested during December-March in Andhra Pradesh.