Demand recovery holds the key
In a positive move, the GST Council has recommended the reduction of GST rates for building materials – plywood, MDF, particle board, veneer, tiles and sanitaryware – and some consumer electricals like fans, switches/switchgears, stabilisers and cables and wires, from 28 per cent to 18 per cent implying 10 per cent reduction in end consumer prices in addition to the excess benefit to be passed on in lieu of higher input tax credits. However, the council has not reduced rates for domestic electrical appliances like mixers, food processors, electric water heaters and others (pre-GST rates were c.24-27%), which otherwise would have been a boost to consumption.
While this move will certainly reduce price differential between branded and unbranded players, thereby creating a level playing field, it should be recognised that significant market share shift will be a function of higher tax compliance on behalf of unorganised players which will in turn depend upon strict and effective implementation of law to check tax evaders. Also, demand for building materials and electricals, like switchgears and wires, would be a function of revival in construction activity. Nonetheless, it would provide an opportunity for companies to improve margins.
* Building materials to be taxed at 18%; construction sector revival key for higher off-take:
GST council reduced rates for building materials like plywood, MDF, particle board, veneer, tiles and sanitaryware (laminates, commercial veneer and faucets were already at 18%) resulting in reduced prices for end consumers and possibly shift towards branded goods on lower price differential with unorganised players. However, demand off-take is expected to be a function of revival in the construction sector for the country. Reduction in rates alone cannot propel growth for the companies. During 2QFY18 earnings call, companies have highlighted that retail demand is yet to pickup.
* Domestic electric kitchen appliances and water heaters continue to be taxed at 28%: The GST Council has not reduced rates for domestic electric appliances like electric water heaters, mixer grinders, food processors, toasters, iron, induction cooktops and other such items which will continue to be taxed at 28 per cent GST (preGST rate of 24-27%). A lower rate would have increased end-consumer demand for these products, however, a higher rate would continue to impact demand scenario in the short-term as highlighted by companies during 2QFY18 earnings call (higher printed tax on invoices i.e. 28 per cent GST vs earlier 14 per cent VAT creating perception that appliances have become expensive post GST).
Nonetheless, tax rate for fans, switches/switchgears, stabilisers (all these had pre-GST rate of 24-27%) and cables and wires (raised from pre-GST rate of c.18 per cent to 28 per cent in July this year) have been reduced to 18 per cent. While, this should support the declining market for fans (companies highlighted in the 2QFY18 earnings), growth in switchgears and wires will be dependent upon revival in construction sector.
* Tax rates cut but market share shift to organised players still dependent upon strict implementation to increase tax compliance: The GST council has reduced rates for the majority of items in building material and consumer electrical space which will lead to lower prices of branded goods for consumers and uptick in demand. However, the market share shift from unorganised to organised players would be dependent upon the strict implementation of the law on behalf of tax authorities to increase tax compliance on part of unorganised players.
With the delay in introduction of e-way bill to at least April 2018, from the earlier timeline of October 2018, and considerable time/data required for performing effective input-output ratio analytics on data captured from invoice-wise matching mechanism in GSTN for input tax credit, benefits of GST would be available for organised players over a longer term.
* Stock view: 10 per cent lower prices and reduced price differential with unorganised players would be highly positive for V-Guard (BUY), Havells (HOLD), Crompton (Not Rated) and all building material companies; though significant market share shift would be visible once tax compliance increases for unorganised players on stricter implementation by tax authorities.