We see the goods and services tax (GST) rate fitment as a key and perhaps the last crucial milestone achieved in the roll-out of the tax regime. In this note, we analyse the new GST rates for various products (and the likely benefits for various sectors/companies). We believe that while corporates would pass on the direct benefits of GST, they would aim to retain partly the indirect benefits from the saving in logistics costs, streamlining of business processes and the seamless flow of input credits.
While GST laws include anti-profiteering measures (which say that the benefits of the reduction in the tax rate and input credit shall be passed on by a commensurate reduction in prices and the government may appoint an authority/empower an existing authority to monitor profiteering), we believe such measures are difficult to implement and would be a retrograde step, similar to price controls, if implemented in haste. First, it would be difficult to assess the commensurate price cuts. Second, the government may not have sufficient bandwidth to check/monitor the pricing/profitability of the entire gamut of tax-paying entities. In our view, pricing/profitability would be driven more by industry dynamics, rivalry and competitive intensity than by government directives on price cuts.
1 July deadline looks realistic now; IT infrastructure a key challenge
With the completion of the fitment of GST rates, a significant milestone in the roll-out of GST has been achieved, and the 1 July deadline now appears realistic to us. However, given that GST is a potentially game-changing indirect tax reform, a few months’ delay cannot be ruled out. It is difficult to envisage ‘complete readiness’ for such a large scale reform, and initial hiccups are more likely than not. Our industry interactions suggest that, while the regulatory framework is on track, front/back end IT support appears to be lagging and remains a key potential challenge. Also, large corporates are more geared up for the implementation relative to entities down the supply chain up to small retailers.
Auto: The standard GST rates across various automotive segments have largely been in line with our expectations: 28% for PVs/2Ws/3Ws and components (batteries) and 12% for tractors. However, the cess has been applied at 1% for small petrol cars, 3% for small diesel cars and 15% for all other categories of PVs. Notably, hybrid vehicles have also been levied a cess of 15%, which we believe is a negative. Broadly, our analysis across segments indicates
that consumer-end prices are likely to fall by ~0%-7%. While 2Ws (>350cc engine) will see no price change, SUV prices can fall by ~7%.
FMCG: We continue to see the impact of GST being positive for the overall consumer sector. Within household and personal care, companies with a portfolio oriented towards hair care and oral care are at a definite gain, while companies with significant focus on beauty and personal care would be impacted negatively due to higher taxation. For retail, while taxation is largely neutral/negative in some cases, we foresee greater benefits for these companies in two ways: (i) these companies will now be able to take advantage of the input tax credit on rent and other operating expenses, which was not allowed before; (ii) competitiveness vs. other unorganised players increases.
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Consumer durables: The consumer durables industry in general will be subject to two GST rates of 12% or 28%. With the exception of LED lamps, pumps and cables and wires, all other product categories for our coverage companies will face a tax incidence of 28%, which is 2-6% higher than the prevailing tax rates faced by these companies (e.g. fans, ACs, luminaries etc). We estimate that this could potentially impact Ebitda margins for these companies in the range of 180-300 bps (the lowest for Havells and the highest for Voltas) without adjusting for the impact of the input tax credit available for items such as the service tax paid on travel, telecom and A&P spends.
Cement: Given that cement demand is recovering gradually from the impact of demonetisation, we think companies will be able to pass on the tax increase through price hikes. We expect cement companies to benefit from the reduced tax incidence on coal and a likely decline in logistics costs. We expect GST to weed out the current inefficiencies in interstate trade (seamless flow of input credits) and drive a substantial reduction in logistics costs.