GTC Industries: Sell

Investors can consider pruning their exposure in the GTC Industries stock, which trades at about 18 times its expected FY-07 earnings. GTC's launch of low-tobacco content cigarettes appears to be driving the stock upwards.

Investors can take advantage of the recent spurt, as valuations appear stretched for a company that is in a mature business. Negligible volume growth in the domestic market, competition from established peers and contingent liabilities are among the key concerns.

Domestic Industry

GTC Industries is among the smaller players in the cigarette industry with a 3 per cent market share. The prospects for revenue growth appear dim as the company relies to a large extent on cigarettes, which contribute 98 per cent of its revenue.

Though the domestic industry has been recording significant growth in value terms, volume growth has been negligible. This value growth has come on the back of a hike in excise duty, which has been to a large extent passed on to consumers.

Consistent hikes in excise duty, severe restrictions on the industry, and health concerns have restricted growth of the cigarettes industry. The domestic industry also faces threat from imports and smuggled cigarettes. Though imports constitute only a negligible portion of the domestic pie, the rising share of imports can pose a threat to smaller players such as GTC Industries.

New Launches

In September, GTC Industries launched `Loe Tabac' in the kings segment to increase its market share in the domestic market. The company plans to focus on this niche segment of low-tobacco cigarettes. Though the launch of this niche product is likely to generate interest among consumers in the near term, sustaining volumes over the long term could prove difficult.

With restrictions on advertising, brand awareness for new products is unlikely to reach the masses and low volumes could significantly hinder brand recall. Poor brand recall, in turn, may impact the viability of maintaining a niche product line. GTC Industries plans to come out with another product on similar lines for the overseas market.

Distribution chain

With restrictions on advertising, GTC has resorted to a more expensive mode of sales promotion. Launches and expansion of distribution channels in rural markets are likely to increase selling and distribution costs further. With a weaker distribution chain compared to ITC, sustaining launches could be difficult.

Operating environment

The potential for earnings growth appears limited, as the scope for volume growth and expansion in operating margins in the cigarettes business is minimal. As GTC Industries operates in a mature business where the competition is high, the scope for better realisations is limited. Besides, with regulation in tobacco cultivation, raw material costs are unlikely to dip. GTC Industries has a set of contingent liabilities, which have been disputed by the company and not provided for.

Direct tax-related items account for a chunk of these liabilities, which are almost five times its annual revenues. The company also faces litigations in the US, which are likely to impede exports.