ITC shares surge 4% despite Q1 profit drop on tax hike, Nomura upgrade

ITC Ltd shares rallied over 4% on Monday even as the company reported a drop in net profit for the first quarter of the current fiscal. The divergence between earnings and market reaction has caught the attention of Dalal Street, with analysts pointing to a key upgrade from a global brokerage as the primary catalyst.

The stock's resilience comes despite headwinds from higher tobacco taxes, which have squeezed the cigarette maker's core business. According to reports, the tax hike has burned into net revenue, volumes, and profit margins during the April-June period.

Why the stock rose despite weak numbers

The immediate trigger for the surge appears to be Nomura's decision to upgrade ITC to a 'Buy' rating. The Japanese brokerage's move has shifted sentiment, even as the company's financials painted a sombre picture.

Market participants seem to be looking past the quarterly dip, betting on a potential recovery in the coming quarters. The upgrade suggests that the worst may be over for ITC's cigarette business, which has historically been its biggest profit driver.

In contrast, Motilal Oswal Financial Services has maintained a 'Neutral' stance on the stock, with a target price of Rs 300. This conservative view underscores the uncertainty surrounding the impact of taxation on future earnings.

Tax hike impact on core business

The central government's decision to increase excise duty on cigarettes has directly hit ITC's profitability. Higher taxes lead to elevated prices, which typically dampen demand and affect volume growth.

For Q1, the company reported a decline in profit, with revenue also taking a hit. While ITC has a diversified portfolio spanning FMCG, hotels, and agribusiness, cigarettes remain the cornerstone of its earnings.

Analysts note that the tax environment is unlikely to ease soon, but ITC's ability to manage costs and innovate in other segments could provide some cushion.

Investor sentiment and market outlook

The stock's gains reflect a broader optimism that ITC can navigate the challenging regulatory landscape. The Nomura upgrade has been pivotal, signalling to institutional investors that the risk-reward ratio is now favourable.

Retail investors, too, appear to be buying into the narrative of a turnaround. The stock's movement on Monday suggests that the market is pricing in a recovery, possibly from the second half of the fiscal year.

However, the divergence between the earnings report and the share price is a reminder that markets often trade on expectations rather than current performance.

What lies ahead for ITC

Going forward, all eyes will be on how ITC manages its cigarette volumes in a high-tax regime. The company's FMCG segment, which includes brands like Aashirvaad and Sunfeast, could play a bigger role in offsetting the drag.

Analysts will also watch for any signs of margin recovery in the coming quarters. A stable tax regime or a shift in consumer behaviour could alter the trajectory significantly.

For now, the market's response suggests that investors are willing to give ITC the benefit of the doubt, but the jury is out on whether the optimism is justified.

The coming quarters will be crucial, as ITC seeks to balance regulatory pressures with growth ambitions. Any further tax hikes could dampen sentiment, but a recovery in volumes or a strong show in non-cigarette businesses might keep the stock afloat.