The new year has brought a severe blow to ITC Ltd, one of India's leading conglomerates, as a massive and unexpected increase in cigarette taxes has sent its stock into a tailspin. The government's notification of revised excise duty rates, effective from 1 February, has sparked fears of a significant dent in the company's core cigarette business, leading to a sharp sell-off in the markets.
A Heavy Tax Burden on the Golden Goose
The government has officially notified changes in excise duty rates on cigarettes, which will come into force on 1 February, replacing the compensation cess. The total tax increase is substantially higher than market expectations, especially when combined with the recent hike in the Goods and Services Tax (GST) rate on cigarettes to 40% from the previous 28% on retail prices.
Analysts from Jefferies India highlighted the severity in a report dated 1 January, stating, "Our estimates suggest that the overall tax burden could result in an effective hike of 50% at the portfolio level." This calculation assumes no change in product mix and the status quo on the National Calamity Contingent Duty (NCCD). For ITC, this news is particularly dire because the cigarette segment is its financial powerhouse.
For the September quarter (Q2FY26), the cigarette business contributed nearly 42% to ITC's standalone total gross segment revenue and a staggering 83% to its Earnings Before Interest and Tax (EBIT). This heavy reliance makes the company extremely vulnerable to any regulatory shocks in this segment.
Price Hikes and Volume Pain: The Inevitable Consequence
The immediate coping mechanism for ITC is straightforward but fraught with risk: increase product prices. However, such a move is likely to be poorly received by consumers, leading to an anticipated drop in cigarette volumes for the financial year 2027 (FY27).
Nomura Financial Advisory and Securities (India) provided a grim forecast in its report. "We believe ITC will have to take a price hike of around 35%+ to maintain margins. This sharp (tax) hike will pressure volumes significantly and lead to a sales decline of 15% year-on-year in FY27," the report stated. The brokerage has consequently downgraded its rating on ITC stock to 'Reduce' from 'Buy' and slashed its FY27 and FY28 earnings per share (EPS) estimates by 18% each.
Another looming threat is the potential boost to the illicit cigarette trade. Higher prices on legal products often drive consumers towards cheaper, untaxed alternatives, which could further erode ITC's market share and volumes.
Stock Under Fire: Downgrades and Valuation Resets
The market's reaction has been swift and brutal. ITC's shares have fallen more than 13% over the past two trading sessions, hitting a fresh 52-week low of ₹345.25 on Friday. This decline follows a 17% drop in the stock's value throughout 2025.
While the previous year's fall had made valuations appear cheaper, the current tax shock has led analysts to reset their expectations fundamentally. Motilal Oswal Financial Services recalled a similar phase of high tax increases between 2013 and 2021, which kept the stock under pressure despite the company protecting its market share and delivering positive EBIT growth.
Nomura has taken a drastic step by reducing the cigarette business's price-to-earnings (P/E) multiple to 16x from 25x on its December 2027 forecasts. The brokerage now values the stock at the lower end of its valuation band, citing expectations that the unprecedented tax hike will severely impact volumes, pressure margins, increase illicit trade, and stifle both growth and the company's ability to attract new consumers.
Consequently, despite the recent beating the stock has taken, the near-to-medium term upside for ITC's shares appears limited. The company now faces the dual challenge of navigating a hostile tax environment while convincing investors of the resilience and growth potential of its other FMCG, hotels, and paperboard businesses in the face of this major setback in its most profitable segment.
