ITC Stock Tumbles 14% on Surprise Cigarette Tax Hike

Introduction

Shares of ITC Ltd., India's largest cigarette manufacturer, plunged nearly 14% over two trading sessions, wiping out approximately ₹63,000 crore in market capitalization. The sharp decline followed a surprise government notification of a steep hike in excise duty on cigarettes, effective February 1, 2026. This policy shock has rattled investors and prompted a wave of downgrades from leading brokerages, who now anticipate significant pressure on the company's volumes, margins, and long-term profitability. The stock hit a three-year low of ₹345.35, reflecting deep concerns about the earnings visibility of its most profitable business segment.

The New Tax Structure Explained

The finance ministry's notification outlined a revised excise duty structure that replaces the previous GST compensation cess. The new framework imposes an excise duty ranging from ₹2,050 to ₹8,500 for every 1,000 cigarette sticks, depending on their length. This duty is levied in addition to the existing 40% Goods and Services Tax (GST) on tobacco products. Analysts estimate this change translates to a significant cost increase. For instance, ICICI Securities projects a 22-28% cost escalation for 75-85 mm cigarettes, a popular segment that accounts for a substantial portion of ITC's volumes. This move signals a tougher regulatory stance on tobacco, aligning taxation more closely with public health objectives, even at the risk of disrupting a major industry player.

Market Reaction and Brokerage Downgrades

The market's reaction was swift and severe. The sell-off was accompanied by heavy trading volumes, indicating institutional selling pressure. The policy shift led at least eleven brokerages to reassess their outlook on ITC, resulting in widespread downgrades and sharp cuts in target prices. The consensus among analysts is that the magnitude of the tax hike was unprecedented and far exceeded market expectations, especially after a period of relatively stable taxation.

Analysis from Financial Institutions

Motilal Oswal described the move as an "unprecedented tax hike" that could reset valuation multiples for the stock. The firm cut its FY27-FY28 earnings estimates for ITC by about 12%, expecting a 6% contraction in cigarette EBIT in FY27. Similarly, Nuvama Institutional Equities highlighted that the hike marked a clear break from the previously benign tax regime. It reduced its valuation multiple for ITC's tobacco business from 23 times to 17 times forward earnings.

JP Morgan flagged "unprecedented taxation blues," warning that ITC might need to implement weighted average price hikes of over 25% just to protect its net realisations. Jefferies echoed this sentiment, estimating that price hikes of around 40% would be necessary to fully pass on the costs, a move that would almost certainly hurt sales volumes. Emkay Global noted that the cigarette business has already seen a sharp de-rating, with its valuation multiple falling from 17 times to 13 times earnings.

The Core Challenge: Price Hikes vs. Illicit Trade

The central challenge for ITC is navigating the delicate balance between protecting its margins and maintaining its sales volumes. Brokerages estimate that the company will need to increase prices by 15% to 40% to offset the higher tax burden. Such a steep increase risks triggering what economists call "demand destruction," where consumers either quit or reduce consumption. More critically, it widens the price gap between legal and illicit cigarettes. A significant price hike could create a "smuggler's paradise," pushing consumers towards the unorganized market, which already accounts for an estimated 23% of the total cigarette market in India. This could erode ITC's market share and undermine the government's revenue collection goals, a pattern observed between FY13 and FY17 when aggressive tax hikes led to stagnant revenue growth.

Resilience in Diversified Businesses

Despite the severe pressure on its core tobacco division, analysts are not forecasting a complete collapse for ITC. The company's diversified business model offers a significant cushion. Its large Fast-Moving Consumer Goods (FMCG) portfolio is expected to benefit from recent GST rationalization in certain categories. The paperboards and packaging segment is anticipated to reach a cyclical bottom by FY27, bolstered by the strategic acquisition of Century. Furthermore, favorable tobacco leaf costs are projected for the upcoming fiscal year, which could provide a modest margin improvement.

The Dividend Safety Net

ITC's long-standing reputation as a 'Dividend King' provides crucial valuation support. Even with the sharp erosion in market capitalization, the stock offers an attractive dividend yield of approximately 4%, backed by a high payout ratio of 85%. This consistent return to shareholders is expected to prevent a terminal decline in the stock price, as it remains a key attraction for long-term, income-focused investors. While the valuation multiple for the tobacco segment has been revised downwards, the reliable dividend acts as a floor for the stock.

Conclusion

The government's sharp excise duty hike has fundamentally altered the investment landscape for ITC. The move has introduced significant near-term uncertainty, forcing a reset of earnings expectations and valuation multiples. The company now faces the difficult task of implementing price increases without triggering a significant loss in volume to the illicit market. While its diversified non-tobacco businesses and strong dividend payouts provide a buffer, the stock's performance in the coming months will depend heavily on its pricing strategy, consumer response, and the government's future policy actions regarding tobacco taxation.