The court struck down government rules requiring larger graphic warnings on packs. A Reuters report said the government will appeal the decision in the Supreme Court, indicating that the legal process will take some time. Still, this is one bright spot. If the rule is eventually struck down, it will benefit ITC in the longer run but the more immediate crisis is the steep increase in taxes.

Between early July, when goods and services tax (GST) was introduced, and now, the broad FMCG sector’s valuations have moved way ahead of ITC’s. The chart alongside shows how Hindustan Unilever Ltd—a company often compared with ITC Ltd—has done and also the BSE FMCG Index. In contrast, ITC has performed poorly.

The pessimism is not without reason. Cigarette volume growth took a hit as the cess led to a sharp hike in prices which in turn affected demand. It also raised the policy risk quotient, as the move was seen more as a means to discourage cigarette smoking than to simply raise revenue. That raises the spectre of more hikes.

The first test of whether the screws will be tightened should be known in early 2018, when the Budget will be announced. As of now, the duties on cigarettes have not been hiked further. If cigarette duty rates are left where they are, in time their effect on growth will lessen.

The general improvement in valuations of consumer stocks itself could be another factor. ITC trades at a price to earnings multiple of 25 times its estimated FY19 earnings, based on the mean of analyst estimates compiled by Reuters. That’s not cheap but it hinges on an earnings growth of 13%. If ITC’s earnings show a possibility of growing higher, those valuations could get more reasonable. Compare that with HUL’s valuations of 47 times with earnings growth of 17% in the same period.

The focus should shift back to how the twin engines of its cigarettes and FMCG business perform. In the September quarter, the unexpected duty hike affected profit growth in cigarettes. That negative impact should not be visible, or at least not as strongly, in the December quarter. The extent to which profit growth of cigarettes recovers, in comparison to September quarter’s growth, is one factor to watch for.

ITC’s FMCG business should benefit similar to its peers, with indications that trade channels are settling down post-GST. Urban markets are recovering though rural appears to be taking time. While sales growth in the September quarter was good, with comparable sales growth of 10%, this should continue and perhaps improve.

The worst on the tax front is already out in the open. The main risks are from taxes being hiked further, which seems unlikely at least in the near term, and from further policy measures to discourage tobacco consumption. Barring these, ITC’s shares could correct the gap that has developed between it and its peers, based on the uptrend in the sector’s valuations and if its cigarettes business steadies itself in the December quarter.