Mar­gin ex­pan­sion to con­tinue for FMCGs

Financial Chronicle - - DEEP DIVE -

The GST Coun­cil has made a no­table change in the man­ner of tax­a­tion of restau­rants with a rather dras­tic re­duc­tion in out­put tax-rate from 18 per cent to 5 per cent, ex­clud­ing restau­rants in starred ho­tels, but with no in­put tax credit en­ti­tle­ment now; there is a pos­si­bil­ity of QSRs (quick ser­vice restau­rants) re­duc­ing end con­sumer prices by 7-8 per cent with­out im­pact­ing their prof­its or cash in­flows. This could prove a big de­mand boost for play­ers like Ju­bi­lant Food­works and Westlife.

The coun­cil also made some other big changes to tax rates, mov­ing most of the items out of the high­est tax bracket of 28 per cent to the 18 per cent slab – key ones amongst these in­clude de­ter­gents (HUL), sham­poo and skin-care (HUL, Dabur), malted food drinks (GSK), choco­lates and cof­fee (Nes­tle), and watches (Ti­tan) as well. Paints was sur­pris­ingly one of the no­table ex­cep­tions that has been left out of the tax-cut ex­er­cise. The unan­swered ques­tion is the mode of off­set­ting the tax short­fall that would arise as a re­sult of the above re­duc­tions – the good news for now is that to­bacco com­pa­nies have not been called upon to bridge the gap yet. Con­sumer sta­ples and QSR stocks are ex­pected to do well on the back of these de­vel­op­ments.

There is a pos­si­bil­ity of 7-8 per cent price cut in QSRs with­out im­pact­ing prof­itabil­ity: With GST rate for restau­rants now re­duced to 5 per cent (vs 18 per cent till now), there is a big op­por­tu­nity for QSR play­ers to cut their menu prices even though the ben­e­fit of avail­ing in­put-tax credit has now been taken away. The GST Coun­cil had, at its ear­lier meet­ing, men­tioned the pos­si­bil­ity of re­duc­ing out­put tax-rates from 18 per cent to 12 per cent with­out in­put tax credit ben­e­fit, so to that ex­tent, the ac­tual out­come is a more favourable one than en­vis­aged.

Even if play­ers cut their end­con­sumer prices by 7-8 per cent, they would still land up with 3-4 per cent higher net re­al­i­sa­tion (ie. rev­enue net of taxes) since tax rates are now sub­stan­tially lower vs what ex­isted thus far. This 3-4 per cent in­crease in net re­al­i­sa­tion is

suf­fi­cient to com­pen­sate for the loss of in­put-tax credit en­ti­tle­ment. Price-cuts of the mag­ni­tude of 7-8 per cent can go a long way in boost­ing con­sump­tion in the sec­tor.

Sim­i­lar story would play out in most other FMCG cat­e­gories: A sim­i­lar ben­e­fit would ac­crue for con­sumer goods like de­ter­gents, sham­poo, skin-care prod­ucts, malted food drinks, etc, which have been re­moved from the high­est tax bracket of 28 per cent to 18 per cent now. This rep­re­sents a clear 10 ppt drop in the out­put tax rate which calls for quite a large price cut to be ef­fected to pass on the com­men­su­rate ben­e­fits to end­con­sumers.

Mar­gin ex­pan­sion for the sec­tor, which has been quite strong in the re­cent 2QFY18 earn­ings-re­ports – that is the first set of re­sults post GST im­ple­men­ta­tion – is likely to con­tinue in the com­ing quar­ters as well, con­sid­er­ing the in­ten­sity of tax-cuts that have now gone through. A no­table ex­cep­tion in our con­sumer cov­er­age group is paints which con­tin­ues to re­main in the 28 per cent tax slab. The sta­tus quo there may even­tu­ally prompt com­pa­nies like Asian Paints to hike prod­uct prices to off­set the in­put costs pres­sure that the in­dus­try has been ab­sorb­ing thus far, likely in the hope of a tax re­lief which doesn’t seem to be a pos­si­bil­ity now.

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