The announced cut in the marginal tax rate cut from 34.9% to 25.2% should mean a 5-13% EPS boost for domestic auto OEMs, but this is priced in. There was no GST cut—tax gains equate to a 1-2% discount, vs 7-8% from a 10% GST cut. The key from here will be the second-order impact of tax cuts on investment, demand and the economic cycle. Higher hopes for FY21e could support valuations, despite near-term (FY20e) earnings cuts. MSIL and MM remain our preferred picks given lower BS-6 headwinds.
5-13% boost to net profit from tax cuts
Given most auto OEMs are operating at a high effective tax rate (ex of other income) with relatively small benefit mainly from R&D- expense-related deduction, we estimate FY20/21e EPS to rise by 5-13% (ex-Tata Motors) as a result of the tax cuts. This benefit should start showing from Q2, with possibly even the write-back on higher taxes provided in Q1 and deferred tax liability reflected in Q2 numbers.
No GST cut for autos, though
The issue of a pile-up of channel inventory ahead of the BS-6 transition in April persists, particularly for two-wheelers and MHCVs. Barring a sharp surge in demand for the rest of the festive season—our channel checks suggest relatively weak demand in the first phase of the festive season in Maharashtra, Kerala, etc – OEMs will have to discount aggressively and reduce dispatches to bring inventory under control, with implications for 2HFY20 earnings. OEMs could choose to pass the tax cut benefit to customers, but this would imply only a 1-2% additional discount vs 7-8% from a 10% GST cut.
Tax relief for new manufacturing cos
The FM also announced a lower tax rate of 17% (including surcharge & cess) for new manufacturing companies set up post-October 1, 2019, and commencing production before March 31, 2023. Although most auto OEMs do not have immediate plans for expansion, given that the benefit runs until FY23e, there could still be some benefit for select companies. Auto ancillary companies benefiting from lower taxes could also pass on some of the gains to OEMs.
Direct earnings impact of tax cut priced in; higher hopes for FY21e
Auto OEMs under our coverage rose
7-18% the day the cut was announced, suggesting the direct benefit of tax cut on earnings has been priced in. We do not expect a significant turnaround in demand immediately and BS-4 inventory correction remains a headwind for 2HFY20. However, the measures have improved the prospects for a quicker & stronger recovery in FY21e which could keep valuations supported despite near-term earnings cuts.
