On his way home from a Chennai construction site, Arumugam stops his bicycle at a shop to buy a Wills Navy Cut filter-tipped cigarette, a popular brand made by ITC, India's biggest tobacco company.
The migrant worker, like many of his countrymen, has cut down on cheap bidis -- a little stick of tobacco rolled in a dry leaf -- and switched to manufactured smokes.
The Navy Cut will give Arumugam, 26, a more reliable drag for his habit, but the main reason he'll pay five times the cost of a one-cent bidi is for a better standing among his smoking friends. "My favorite [film] hero also smokes cigarettes," he says, and he's pushing his father to shift from bidis as well.
In a nation of 270 million smokers, only 15% have made that switch, leaving a big opportunity for ITC and its domestic rivals. Although ITC (once Imperial Tobacco Co.), with $3 billion in sales, would like to diversify from cigarettes, which still account for 70% of sales, it is loath to walk away from their addictive profitability -- smokes are 84% of its impressive $500 million in post-tax earnings.
Merrill Lynch forecasts ITC's operating income (profit before interest and taxes) will grow 20%, compared with less than 10% for most cigarette companies globally.
Smoking is frowned upon in polite Indian society. But India is the third-largest producer and second-largest consumer of tobacco in the world. Most goes into the bidis, which enjoy political patronage and low taxes. (Cigarettes are taxed 30 times higher on a per-kilo basis, says ITC.) Hundreds of bidi makers scattered across India employ 5 million women and children in impoverished homes for a few cents per day. (ITC employs 20,000.)
Chewing tobacco, sold in single-use, colorful sachets in roadside shops, is an estimated $5 billion industry and accounts for nearly 30% of the country's tobacco market. It offers a bigger kick and skirts the spreading smoking bans but gives India one of the world's highest rates of mouth cancer.
Put that together and you get cigarette consumption far below that in China and even less than in smaller Indonesia. Yet bidis are for the poor, and India aspires to be richer. After falling in 2001, following a tax hike in 2000, cigarette sales are climbing again (see chart).
Western brands can come in but face a 30% import tax (smuggling is rampant) -- plus, cigarette advertising is restricted. So tobacco multinationals figure they'd best take a stake in a local producer, as Britain's BAT has in Kolkata's ITC (32%).
Altria, the world's largest cigarette maker, holds, through Philip Morris International, a 36% stake in ITC rival Godfrey Philips. (The U.S. giant tied up with China National Tobacco in December to make and sell Marlboro in China, and it paid $5 billion last year to buy Sampoerna, Indonesia's third-largest cigarette maker.)
Unlike in the West, cancer-related litigation is not a big risk factor for the industry in
Kunal Motishaw, who tracks the sector for Equitymaster, a Mumbai equity research firm, estimates that a 10-percentage-point increase in excise will hurt ITC and other cigarette makers, who have been spared a large hike since 2002 (there was a 10-percentage-point tax hike last year). Volumes dipped after a tax hike of 15 percentage points in 2000-01.
But with cigarettes contributing 10% of the excise (indirect tax charged on domestic sales of products) revenues to a deficit-ridden exchequer, the government must tread with caution, lest it cripple sales.
ITC under Chairman Yogi C. Deveshwar has doubled revenues in a decade on the back of cigarette sales that are rising 13% a year. It owns six of the top ten brands in India, and in that favored position is less affected by the limits on ads. Yet Deveshwar, 58, an ITC veteran (barring a short stint as head of India's international carrier, Air India), is himself having to tack through changing social and political winds.
He resolved a long-running dispute with the government on cigarette taxes and has tried to keep imports from getting too big an opening in the country's balky liberalization. All the while, he's committed cash from cigarettes to new businesses, much as Philip Morris/Altria diversified (with mixed results) into Kraft foods and Miller beer.
In fact, appearing before an auto group last September in his capacity as head of the Confederation of Indian Industry, Deveshwar said, "In the future, there will be no resistance from ITC if the government decides to extinguish the tobacco business." He continued, "We are creating value in other areas."
When Deveshwar took over ITC in 1996, it was a cigarette company. After exiting failed investments in financial services and edible oils that he inherited when he took over, he pursued ventures where ITC could use its strengths in distribution, branding and services. A logical extension was fast-moving consumer goods, because ITC could sell foods through a network of 1.5 million small food stores in India that also sell cigarettes.
The chairman declined to be interviewed for this article, but he is pushing businesses ranging from foods to retail to hotels. He took Wills, the primary cigarette brand, and downplayed it on the smokes' packages, instead flaunting it to sell ready-to-wear garments through ITC's own Wills Lifestyle retail stores.
But new businesses, including foods and cyber-based support services to agriculture, are losing money. The latter, called e-choupal ("choupal" means "village gathering place" in Hindi), provides something like rural Internet kiosks, which initially distributed information on prices, weather and crop practices to farmers.
ITC, which has a special license to buy directly from farmers, bypassing state-mandated traders, used 5,200 choupals in 31,000 villages to source agricommodities from farmers at better prices and consistent quality. Some farmers sell through e-choupals because ITC pays in full and weighs the produce correctly.
But revenues are slow to build because there are no immediate returns on the $5,000 spent to set up an e-choupal. The money will eventually come from selling goods and services to farmers.
Meantime, losses from sales of biscuits, flour, retail and confectionery ran to $29 million for the nine months ending in December 2005, though revenues rose 81%.
ITC expects the foods division to break even in 2008 but is noncommittal on e-choupals. "Our honeymoon gets over soon," says Ravi Naware, foods unit boss.
But thanks to millions of new customers like Arumugam, and notwithstanding which way the state's winds blow, both India's and ITC's honeymoon with cigarettes is likely to continue.