TAX CUTS A BOOSTER FOR CONSUMER COMPANIES

While lower corporation tax improves earnings and re-rating potential, passing on the gains to end consumer may not yield desired results if household incomes do not improve, say analysts

The major tax relief to India Inc announced last Friday came in as a great festive surprise and also led to a 4.4 per cent jump in the Nifty FMCG (fastmoving consumer goods) index. However, the Street is awaiting how FMCG players would utilise the expected tax savings — to propel volumes or gain market share amid slower demand.

Nonetheless, lower tax rates mean a direct push to earnings and so to their return ratios, and hence more room for valuation rerating, if companies decide to retain all the benefits, as some analysts are currently assuming.

As against the new effective tax rate of 25.17 per cent, major FMCG players, such as Hindustan Unilever, Nestlé, Britannia, and Colgate, saw tax rates of over 30 per cent, according to FY19 financials (for Nestlé, it is based on CY18 numbers as it follows the JanuaryDecember accounting period). The tax rate for paint companies, such as Asian Paints and Berger Paints, in FY19 ranged from 28 per cent to 35 per cent.

Vishal Gutka, vice-president at Philip Capital, roughly predicts 12-15 per cent earnings upgrade for consumer companies with high existing tax rates (upwards of 30 per cent). “However, any immediate sharp volume support is unlikely, unless income levels of consumers improve,” Gutka adds.

The actual impact of lower taxes will vary across companies, depending on their existing tax strategies. For instance, companies, such as Dabur, Marico, and Godrej Consumer Products, which are already enjoying tax rates below 25 per cent, would not see any major benefit.

Though after Titan’s announcement of passing on tax savings to the end customers, some experts believe that if others join the suit and demand (volumes) doesn’t follow, it may negatively impact their operating profitability and the expected earnings gains.

According to Sachin Bobade, vice president-research, Dolat Capital, “In a dismal demand scenario, price cuts are unlikely to support volume growth and could pull down the overall top line and expected earnings growth. This, in turn, would hurt valuations.”

The recent observations, too, underline this argument. For instance, sharp price cuts by the major players in the soap segment failed to propel volumes, say analysts.

Nitin Gupta, analyst at SBICAP Securities, echoes similar views. “If companies now pass on the gains from lower tax to end customers, it would result in Ebitda (earnings before interest, tax, depreciation and amortisation) margin contraction,” he says. However, the earnings upsides, amid expectations that companies will retain the tax benefits, have improved re-rating potentials for many FMCG companies, Gupta highlights. Also, since soaps belong to a relatively mature category, the jury is out on how companies and customers will respond to passing on of tax rate cuts.

The festive season and overall monsoon progress, though erratic in some parts of the country, could be a near-term volume supporter for consumer companies.

Among other strategies, which companies may deploy, include giving a higher margin to dealers and strengthening new pipeline, mainly high-margin premium products. The latter should offer good volume and earnings growth over the medium term. This is because the benefits of the lower corporation tax rates are expected to flow strongly over a period.

“While the near term impact may be moderate, over the medium to long term, it will spur investment, employment and higher disposable income,” says Vivek Karve, chief financial officer, Marico.

Apart from the corporation tax bonanza, some consumption pockets, such as hotels and cigarettes, are expected to benefit even from Friday’s good and services tax (GST) council announcements. While no GST hike provides relief to cigarette companies, which always face tax overhang, hotels could see an improvement in occupancy with lower GST on hotel accommodation (up to 18 per cent, from 28 per cent earlier). Thus, stocks such as Indian Hotels, Lemon Tree, and cigarette major ITC could see further investor support.