ITC Stock Tumbles as Brokerages Downgrade on Tax Shock

Introduction

Shares of ITC Ltd. plunged to a three-year low, erasing over ₹70,000 crore in market capitalization in just two trading sessions after the government announced a steep and unexpected hike in excise duty on cigarettes. The move, effective February 1, 2026, abruptly ended a multi-year period of stable taxation for the industry. The market's reaction was severe, prompting a wave of downgrades from major brokerage firms who are now forecasting significant pressure on the company's sales volumes, earnings, and stock valuation.

The Unprecedented Tax Hike

The government's notification outlined a revised excise duty structure, imposing a levy ranging from ₹2,050 to ₹8,500 for every 1,000 cigarette sticks, depending on their length. This duty is in addition to the existing 40% Goods and Services Tax (GST). Analysts at several firms described the move as an "unprecedented tax hike" and a "fiscal bombshell." The new structure is expected to increase the total tax burden on cigarettes from approximately 53% to over 61%, pushing it closer to the World Health Organization's recommended benchmark of 75%. This sudden shift marks a clear departure from the rational tax policy of recent years, which had helped the organized cigarette industry gain market share from illicit players.

Market Reaction and Stock Performance

The financial markets responded immediately and negatively to the news. ITC's stock fell nearly 10% on the first day of trading in 2026 and continued its slide the following day, ultimately dropping around 14-15% over two days. The share price hit a three-year low of ₹345.35, a level not seen since early 2023. The sharp sell-off was driven by investor concerns that the substantial tax increase would force ITC to implement significant price hikes, thereby hurting consumer demand and long-term profitability.

A Wave of Brokerage Downgrades

Leading brokerage houses swiftly reassessed their outlook for ITC, resulting in a cascade of rating downgrades and sharp cuts in target prices. The consensus view is that the tax shock fundamentally alters the investment thesis for the stock in the near to medium term. Firms cited risks of volume decline, margin pressure, and a necessary de-rating of the cigarette business's valuation.

Here is a summary of the revised recommendations from key brokerages:

Projected Impact on ITC's Business

Analysts project that ITC will need to implement weighted average price hikes ranging from 25% to as high as 40% across its portfolio simply to maintain its current net realization per stick. Such a steep increase in consumer prices is expected to have a direct impact on sales volumes. PhillipCapital forecasts a 12.5% decline in cigarette volumes for FY27, while Nomura anticipates a 15% drop. This potential for "demand destruction" is a primary concern, as consumers may reduce consumption or switch to cheaper alternatives.

Risk of Illicit Trade and Down-Trading

A major consequence of the tax hike is the widening price gap between legal and illicit cigarettes. The stable tax regime had helped the legal industry, including ITC, to grow volumes at a 5% CAGR over the last five years by making illicit products less attractive. Analysts now warn that the sharp price increase could create a "smuggler's paradise," reversing these gains and fueling the unorganized market, which already holds an estimated 23% market share.

Earnings Forecasts and Valuation Reset

Reflecting the anticipated volume pressure, brokerages have slashed their earnings estimates for ITC. Nuvama cut its FY27 and FY28 EBITDA estimates by 7% each, while Nomura reduced its EPS estimates for the same period by 18%. This earnings pressure has also led to a valuation reset for ITC's core cigarette business. Motilal Oswal, for instance, cut its valuation multiple for the segment to 14 times forward earnings from 17 times, while Nuvama reduced its multiple from 23 times to 17 times.

Mitigating Factors and Diversified Portfolio

Despite the severe headwinds in the tobacco segment, most analysts stopped short of an outright 'Sell' rating. This is largely due to ITC's diversified business structure and strong financial position. The company's high dividend yield of around 4%, supported by an 85% payout ratio, provides a valuation floor for the stock. Furthermore, its non-tobacco businesses offer a buffer. The large FMCG foods portfolio could benefit from GST rationalization, while the paper business is expected to see margin improvement. Favorable raw tobacco costs in FY27 could also provide a partial cushion against the excise duty impact.

Conclusion and Forward Outlook

The government's decision to sharply increase excise duty on cigarettes marks a pivotal shift in the operating environment for ITC. The era of stable taxation and predictable volume growth is over, replaced by a period of significant uncertainty. The company now faces the difficult task of balancing substantial price increases to protect margins while trying to mitigate the inevitable decline in sales volumes. Investors will be closely watching ITC's pricing strategy and the resilience of its non-tobacco segments to offset the pressure on its core business.