The government’s surprise move to bring down corporate tax rates may benefit most FMCG companies but they are unlikely to pass on the benefits to consumers, Kotak Institutional Equities has said.
History suggested that these companies pass very small benefits to consumers and retained most of tax cut with them for reinvestment, growth and operating stability, the brokerage said.
The Indian CPG (consumer packaged goods) sector was not the most competitive and generally companies retained windfalls elsewhere—be it in raw material deflation phases or the upside from goods and services tax implementation, it said.
“We would not expect a different outcome this time. We are not suggesting that we don’t see a few price reductions here and there. Such moves are unlikely to be dilutive to absolute operating profits, however," the brokerage said.
Any reinvestment would be used as a “fuel for growth or fuel for accelerated premiumisation”, ensuring operating profit neutrality, Kotak said, adding to assume otherwise would fly in the face of historical evidence. "We see no reason to challenge history."
The government has cut marginal and effective tax on companies to 22 percent from 30 percent and 25.6 percent from 35 percent, respectively. Companies that move to the new marginal/effective tax rate would have to forgo any exemption they are currently availing.
"We expect companies such as Dabur, Marico, Godrej Consumer and Bajaj Consumers to opt for status quo, ie continuing to avail exemptions while staying at a marginal tax rate of 30 percent given that their current ETR (effect tax rate) is below 25.6 percent, anyway. These companies do have the option of moving to the new marginal tax rate of 22 percent at a later date, when the tax exemptions start to expire and a move becomes a better choice," Kotak said.
In addition to the cut in the marginal tax, the government has also said that a new domestic company incorporated on or after October 1, 2019 making a fresh investment in manufacturing can avail an even lower marginal tax rate of 15 percent (17.5 percent effective). This benefit will be available only to the companies that commence production on or before March 31, 2023.
Kotak said it would expect companies in its coverage universe to (a) set up new subsidiaries for any new capacity expansion to avail of this benefit, and (b) get their third-party manufacturing partners to do the same and pass on the benefit.
According to the brokerage, companies in its universe may see 0-18 percent earnings growth in the current financial year.
United Breweries, Asian Paints, Britannia Industries, Colgate, GSK Consumer, ITC, Jubilant Foodworks, Nestle, Page Industries, United Spirits, Pidilite Industries and Page Industries could see more than 10 percent earning growth.
"We have heard different things from companies paying MAT currently—Dabur and Marico are suggesting no/immaterial impact, while Godrej Consumer has indicated a 350-400 bps lower ETR on standalone earnings," said Kotak, which upgraded ITC to buy from add and United Breweries to add from reduce.
The government’s intent behind the bold move was to drive accelerated investments in manufacturing.
"If this were to happen, potential higher job creation, increase in GDP growth pace and associated multiplier effects could mean a sharp acceleration in consumer demand. That said, maybe this move just about prevents any downgrades in revenues and earnings estimates for the consumer packaged goods companies that would have otherwise happened," it said.
Disclaimer: The above report is compiled from information available on public platforms. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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