Motilal Oswal Financial Services has shifted the investment outlook for FMCG major ITC Ltd, as the brokerage has downgraded the stock from BUY to Neutral with a revised target price of Rs 400, implying a modest 10% upside from current levels. The trigger is not operational complacency, but an unprecedented increase in cigarette taxation, effective February 1, 2026, which threatens to reset industry economics after several years of stability. While ITC’s diversified portfolio and execution capabilities remain intact, analysts now expect earnings pressure in the core cigarette business, valuation multiple compression, and near-term loss of catalysts that had supported the stock’s strong run over the past five years.

Unprecedented Cigarette Tax Increase Alters the Operating Landscape

The government’s latest notification delivers a tax shock rarely seen in modern Indian tobacco history. Cigarette taxes have been raised by approximately 40–50% at a portfolio level, assuming the continuation of the National Calamity Contingent Duty (NCCD). Additionally, under GST 2.0, the GST rate on cigarettes will rise from 28% to 40%, also effective February 1, 2026.

For ITC, this translates into a harsh arithmetic reality. To merely maintain current net realization per cigarette stick, the company would need to implement a minimum 25% price hike across its cigarette portfolio. This is a steep adjustment in a category where affordability, price ladders, and consumer down-trading play a decisive role in volume sustainability.

Tax Stability Had Fueled Legal Market Gains—That Phase Is Now Over

The timing of the tax hike is particularly disruptive given the recent history of stability. Over the last four to five years, steady taxation had narrowed the price gap between legal and illicit cigarettes. As a result, the illicit cigarette market lost roughly 150 basis points of volume share, contracting to about 26%, while legal players benefited.

ITC capitalized on this environment. Cigarette volumes delivered a ~5% CAGR over the last five years, new product launches improved mix, and investor confidence surged. The stock rose more than 50% during this period. Motilal Oswal now argues that this favorable phase has decisively ended.

Illicit Cigarettes Regain Competitive Edge

The sharp tax increase risks reviving the illicit cigarette trade. With legal cigarette prices set to rise sharply, the price arbitrage between legal and illegal products will widen once again. History suggests that such gaps encourage volume migration to illicit brands and down-trading within legal portfolios.

Analysts warn that even premium players like ITC are not immune. While brand strength offers some insulation, consumer elasticity in the mass and mid-price segments could meaningfully dent volumes, particularly if price hikes are implemented too aggressively or too quickly.

Product Mix Strength Weakens as Price Hikes Dominate Strategy

ITC’s recent product innovation cycle was built on tax stability. Over the last few years, the company actively launched new variants, expanded price points, and improved mix to drive profitability. The required price hikes now threaten to undo these gains.

Instead of trading consumers up, ITC may be forced into a defensive stance—prioritizing margin protection over mix enrichment. According to Motilal Oswal, this shift structurally weakens the cigarette portfolio’s earnings quality in the near to medium term.

Lessons From the Past: High-Tax Cycles Keep Stocks Range-Bound

Historical context provides a sobering backdrop. Between 2012 and 2020, cigarette taxes were increased seven times in nine years. During that phase, ITC managed to protect market share and deliver positive EBIT growth, yet the stock remained largely range-bound, reflecting persistent valuation pressure.

This time, the tax increase is sharper and more abrupt. Motilal Oswal now models a 6% EBIT contraction in FY27, reflecting the combined impact of price hikes, volume elasticity, and mix deterioration. Consequently, EPS estimates for FY27 and FY28 have been cut by approximately 12%.

Near-Term Catalysts Fade as Earnings Pressure Builds

The stock has already reacted. ITC corrected by about 10% on January 1, 2026, signaling early market recognition of the challenge ahead. More importantly, earnings pressure in cigarettes removes several comforting near-term narratives—soft tobacco leaf prices, recovery in FMCG margins, and improvement in the paper segment—that had previously supported valuation confidence.

With cigarette profitability under scrutiny, the market is likely to demand greater proof of resilience from ITC’s non-tobacco businesses.

Valuation Reset: Cigarettes Revert to High-Tax Multiples

Motilal Oswal’s valuation framework reflects a clear reset. The brokerage now values ITC’s cigarette business at 14x Dec’27E EV/EBITDA, in line with multiples seen during earlier high-tax cycles. This is a sharp downgrade from the 17x multiple previously assigned.

The revised Sum-of-the-Parts (SoTP) valuation yields a target price of Rs 400, leading to the downgrade from BUY to Neutral. Analysts emphasize that valuation compression—not balance-sheet weakness—is the primary driver of the downgrade.

Financial Snapshot: Growth Continues, But at a Slower Pace

Below is a snapshot of Motilal Oswal’s updated projections:

Investor Takeaway: A Defensive Giant Faces a Policy-Driven Reset

ITC remains a high-quality franchise with strong cash flows, market leadership, and diversification. However, Motilal Oswal’s downgrade underscores a critical reality: policy risk has re-entered the equation in a meaningful way.

In the near term, the stock is likely to remain range-bound, as investors reassess earnings durability, cigarette pricing strategy, and the pace at which non-tobacco businesses can offset pressure. Long-term investors may still find comfort in ITC’s balance sheet and dividend yield, but valuation upside now appears capped until tax visibility improves.