CHENNAI: The domestic cigarette industry is preparing for a moderate contraction in volumes next fiscal, with sales expected to decline by 6–8% following a fresh round of tax changes that take effect from February 1. While the new duty structure will raise prices across segments, its impact is likely to vary between mid-to-premium cigarettes and the mass segment, shaping both pricing strategies and profitability outcomes for manufacturers, according to a latest report from rating agency Crisil.
At present, cigarettes attract 28% goods and services tax (GST) along with a compensation cess that differs by product category. From February 1, the compensation cess will be abolished and replaced with an additional excise duty, ranging from Rs 2.05 to Rs 8.5 per stick depending on cigarette length. Mid-to-premium cigarettes, defined as those longer than 65 millimetres, will face an excise duty of Rs 3.6 to Rs 8.5 per stick, while cigarettes in the mass segment, measuring less than 65 millimetres, will attract Rs 2.05 to Rs 2.1 per stick. In addition, GST on the final retail price will be increased to 40%.
Although the absolute duty hike is steeper in the mid-to-premium segment, manufacturers are expected to pass on most of this increase to consumers, given stronger brand loyalty and lower price sensitivity in this category. In contrast, the mass segment, which accounts for roughly 40–45% of industry volumes, is expected to see partial absorption of the duty increase by manufacturers to limit volume erosion. As a result, industry-wide earnings before interest and tax margins are likely to compress by about 200–300 basis points, but are still expected to remain at healthy levels.
An assessment of the three largest cigarette companies, which together account for more than 95% of organised industry volumes, suggests that the sector’s credit profile will remain largely resilient. Strong operating cash flows, negligible debt, and sizable cash reserves are expected to cushion the near-term pressure from higher taxes and softer volumes.
According to Shounak Chakravarty, Director at Crisil Ratings, the duty hikes translate to roughly 25% of the current maximum retail price in the mid-to-premium segment, where companies are likely to pass on most of the increase. In the mass segment, where the hike is closer to 15% of current MRP, manufacturers may absorb part of the impact to protect volumes. Even so, overall industry volumes are expected to decline by 6–8% next fiscal, broadly in line with past experiences following tax increases.
Historical trends underscore the sensitivity of cigarette demand to sharp price increases. Between fiscals 2014 and 2018, successive duty hikes led to a cumulative 40–50% rise in MRPs and a roughly 20% drop in volumes, with manufacturers taking three to four years to recover lost sales. This experience is likely to prompt a more calibrated pricing approach this time, particularly in the mass segment.
While companies with a higher exposure to the mass segment may face a relatively greater margin impact, overall profitability is expected to remain robust, with EBIT margins projected to stay above 58% next fiscal. Healthy liquidity, debt-free balance sheets, and cash surpluses exceeding Rs 20,000 crore also provide headroom for continued product innovation and brand investment.
Going forward, the key risks to monitor include a sharper-than-anticipated fall in volumes and the possibility of additional tax hikes, either of which could weigh more meaningfully on growth and profitability, stated the Crisil Ratings report.