Anti-profiteering clause may prove to be a temporary measure: Sanjay Mookim, BofA Merrill Lynch
India’s growth is perhaps more assured than you would imagine
Talking to ET Now, Sanjay Mookim, India Equity Strategist, BofA Merrill Lynch, says India’s growth is perhaps more assured than you would imagine and because it is a consumption driven economy, strong consumer companies with good business models should continue to compound.
What do you make of the anti-profiteering clause and the stringency with which the government would want it to be implemented so that consumers are not short changed by businesses in transferring the benefits under the new tax regime?
The anti-profiteering clause appears to be a statement of intent by the government that they would like businesses to pass on whatever tax savings have been made under the GST to consumers. However, in a country of 1.3 billion people and hundreds and thousands of enterprises, it is extremely difficult to have the institutional capacity to monitor margins across businesses and companies. Much of the action of the anti-profiteering body will be on a complaints basis rather than for them to take suo moto action against the companies. It is practically impossible for that to happen. Somebody will have to go to the authority and point out a particular business or an industry which they think has not passed on GST benefits to consumers.
The second layer of course is establishing the fact that the margin expansion that the company has retained is because of lower taxes and not because of improvements in other costs or product mix. Again this becomes very difficult to establish and it will of course create challenges in litigation. I do not think that this is going to become a pervasive sort of an issue. I suspect this has been introduced into the law more as a statement of intent, more to tell companies and businesses that you should try and pass on whatever tax savings you have to consumers. I suspect this will be extremely impractical to roll out on a mass scale across the country.
Even if it is a work in progress as is the bill itself, and by its implementation would the government be indicating that they are looking at setting up a national anti-profiteering authority which can deal with these sort of gaps or errors in the system, can process complaints where the pass through has not happened? That would perhaps be a step in the right direction. I am not saying it may happen overnight but as long as the government is trying to put the checks and balances in place, at least a direction is right?
Well yes, from a policy perspective it makes sense to ensure that tax savings are passed on to consumers and that there is no profiteering on the back of a windfall gain to companies because of a change in taxation. However, if you think about it, one year to 18-months down the line, this will no longer be necessary because the prices on margins should probably have stabilised. So this will prove to be a temporary measure and for a while that the taxation is transitioning, it probably will not be necessary one-two years down the line anyway.
Do you think that these gaps in the system and perhaps the lack of clarity may lead to an interim boost in inflation, something that would get the RBI also a bit conscious about whether or not to go ahead and cut rates? Many countries that adopted GST in the past like Singapore and Australia witnessed the same sort of reaction once the model came into place.
This is a big unknown in India in fact we did a short survey today where we went and met about 25 retail store keepers, we asked them what prices will do post the GST and surprise surprise, not one seems to know what will happen to their goods or how their businesses will fare after GST comes into play! It is a risk and we do not know really whether inflation will go up or not. But the way the rates have been designed, they are broadly similar to where the old rates were without taking into effect the input tax credit. It seems unlikely that there will be inflation. Conceptually there should not be because the headline rate is similar to the old one and now have better input tax credits. It should not be inflationary but the risk is that the misunderstanding the gaps in people’s processes may lead to some sort of pricing upside in the short term. I would not be too worried about it, to be honest.
Let us talk about how you are looking at your India strategy in lieu of GST becoming a reality. Have you at all worked out a range for what GST could do for earnings in FY18? FY19 is a foregone conclusion, there is going to be a big boost on numbers but how does one actually navigate through this year when it comes to earnings in lieu of the spectacular rally the markets have already witnessed?
Given the rich valuations to market, any hiccup in numbers should ideally be a risk to worry about and the GST is if indeed a hiccup at least to the June quarter and potentially September quarter as well. The magnitudes of course very difficult to establish but it should be noticeable. We already hear commentary from many companies telling us that their sales are weak. We know through experience that destocking is relatively visible across most stores in the country and whether the market looks through this or not I think will be determined by the mood of the market at that point in time.
We keep highlighting in our strategy notes that India is joined at the hip to global equity sentiment, to emerging markets, to global equities. All charts are almost 100% correlated for a long period of time. All Indian strategists sitting here would like to talk about Indian growth and try and explain the multiples by pointing to the growth but that really is not why stocks are at 30, 40, 50 times earnings in India.
Consumer, discretionary, staples all have rerated everywhere in the world as well. India just happens to trade a premium. In that environment, I am not so sure that the GST hiccup in itself will lead to meaningful correction in the market. This is especially if you remember after the demonetisation a lot of our investors got the demonetisation trade at least incorrect when they sold into demonetisation.
The GST at least can be argued to be good for the country over a two-year period and having had the poor experience of selling in December, I suspect not too many will be eager now to sell any temporary GST bump. Numbers will be not affected but I am not sure that the market will react meaningfully on the downside just because of GST. However, we are already tarting to see global jitters in equity. If , if that were to continue, then that could be the reason Indian markets take a leg down as well.
Suffice to say the very narrow range that the market has been trading in the last 15 odd days where the levels are being slowly, gradually adjusting lower, you do not think this is squaring off of positions, taking positions off before GST becomes a reality? Do you think this is more in tandem with just valuations looking a bit stressed so traders can be a bit cautious?
Yes, there is a dearth of ideas to be honest. You can find growth, you can find value but there is no overlap between growth and value in India anymore plus as I said you have seen jitters all across the world. It is not just Indian equity that has taken a breather, we have seen equity markets elsewhere also pause. We are doing that in sympathy as well and if you start seeing global rates go up, global inflation expectations go down and emerging market asset classes correct, then India again will not be decoupled especially with the concerns around the GST around the corner.
I do think that we are susceptible as a market and our advice to investors has been to avoid risk in India, risk being liquidity and operations because markets are fairly valued but again like I said the GST in itself absent any other external stimulus may not be sufficient to cause a noticeable correction.
We have seen a rally in consumer stocks that reflects that the market is very upbeat on what the new regime would mean for these companies. Tthat has been pretty much case with the logistic companies and airlines too. GST will be just 5% on economy flying so there is some upside there as well but for names within the consumer durables space, automobile space it is a mixed picture. How do you look at the sectors which may go through a bit of a struggle when it comes to adjusting to the new regime or to the new tax reform?
First, I would say that there is no obvious trade on the GST in the market simply because that would have been through lower tax rates. Now that has not really happened across most spaces. In most industries tax. rates have been largely kept similar to where they are, there has not been significant reduction in rates for many sectors so that trade is not available. The difficult trade is available which is for companies to use the GST and either gain market share from their unorganised counterparts to try and expand the market or through better product mix and so on.
I would argue that given the expectations that is in built into many of the stocks now it is only post evidence of that happening that I get further upside. Much of the hope of GST in many of the staples, many of the smaller sectors has already been factored in logistics like I said or consumer durables and I need evidence that the GST is working for many of these before you start to get a fresh leg to these sub sectors or to the stocks, there is no obvious trade at the moment.
I do not see too many downside ones as well all I would say is that the service sector which is let us say banks or telecom will have a far larger compliance cost because they now have to file in more states not just one sector and to not just in the centre and therefore their cost may go up but I do not see too many large evident losers of the GST as well.
But how would these compliance costs work because we know the telecom story. The bias is really towards spending more in whichever form and shape. So another cost perhaps bearing on their P&Ls.
Yes and telecom service tax is now payable in each state every month and allocation will become an issue. These things need to be sorted out. They will probably need to add more tax people, more IT systems and of course most of them have already worked on it. But some portion of higher cost can be expected post the GST. It should stabilise, the GST is very automatic, it is very technology heavy. Once you are able to automate it, once you are able to get the process in place, then the cost should probably come down. But while you are doing it, while you are getting your vendors up on board as well, a lot of effort, time and money is going to be needed and this is not just for telecom. Telecom or services will particularly face this brunt but most companies will have a lot of cost initially while in both time and money in how they adapt to the GST, how they get their ecosystems, vendors and consumers to understand the whole process. The market is going to see higher costs in most spaces for some time.
As a theme that would clearly stand out even though it is coming at a price is the consumer story. Consumption names, the FMCG stars – Colgate, Heritage Foods, Marico, Dabur, Nestle, HUL, for that matter even ITC. But do you think that is where the focus should lie in terms of buying even at these levels?
Especially if you have a longer term investment horizon. It is extremely difficult to say in a two-month space but if you are a long-term investor in India, it is one economy which is consumption driven and has growing standards of living or higher per capita income visibly over the next three to five years. We did a note on this some time ago to argue why the drivers are stronger than you think, India’s growth is perhaps more assured than you would imagine and because it is a consumption driven economy, strong consumer companies with good business models should continue to compound.
In fact, this is an argument we made that India actually has the highest yield of compounders in its equity compared to any other global large market and that is simply because we are consumption focussed and that theme will play out. GST can only help facilitate some of that but the underlying currents are extremely strong anyway. If you have a long-term horizon, I do think India inward focussed companies, good ones are the way to go.