Tax collections have a direct correlation to earnings growth. Earnings seem to be bottoming out for several sectors in FY20 and are likely to range from flat to better in FY21.
- By Vinay Pandit
Tax collections have a direct correlation to earnings growth. Earnings seem to be bottoming out for several sectors in FY20 and are likely to range from flat to better in FY21, especially led by sectors like auto, auto ancillaries, infrastructure, T&D, pharma, defence, retail and BFSI amongst others. However, due to the lower corporate tax rate announced this year, and an expectation of change in personal tax slabs, growth in direct tax collections can be expected to be flat to marginally positive next year. An indirect method to push up tax collections is to improve the demand and consumption cycle. Government needs to take adequate measures to improve demand factors such as easing income tax slabs, ensuring faster pass-through of interest rate cuts, ease of doing business for corporates, and avoiding too many regulatory changes (read: stable regulatory regime), thereby leaving greater cash flows in the hands of consumers and corporates for eventual spending.
While supply-side cash flows are being addressed, demand-side aspects need to be addressed too. The single most important factor will be easing the tax slabs, which will leave more cash flows in the hand of taxpayers and help increase the number of tax filers. I hope to see some positive announcements on this front in Budget 2020, which will be a big boost for consumption as well as markets on the whole. I expect the government and RBI to be focused on a faster pass-through of lower interest rates to end borrowers, before any major rate cuts in the future.
The Indian economy is at a phase where it is bottoming out and is poised for strong potential growth for the next 4-5 years. We expect it to be more of a gradual recovery rather than a J curve recovery. Market caps and multiples have moved ahead of fundamentals in several quality frontline companies. However, there are several sectors, which are coming out of a dip seen in the last 1-2 years such as auto OEMs, auto ancillaries, apparel retail, textiles, banks, NBFCs (such as housing finance companies), metals and T&D companies (led by PGCIL).
We expect these sectors to show positive growth trends in the coming year. We expect auto and auto ancillary companies to do better in FY21 led by a complete shift to BSVI, thereby leading to significant primary sales (despatches) by auto OEMS. Dealers are currently sitting on soft 20-25 inventories as per our channel checks, with several two-wheeler manufacturers such as Hero MotoCorp, which, along with current production in progress for BSIV, will see a complete liquidation of inventory by Feb 2020. Post that, we expect sub-dealers to start picking up higher inventories of new BSVI vehicles, which will, in turn, drive primary sales.
This will also drive higher sales for auto ancillaries. Both auto OEMs and auto ancillaries are currently sitting on decade-low valuations, and are ripe for cherry-picking by long-term investors. I am also expecting strong pickup in infrastructure, driven by road modernisation projects (including expressways), increased focus on waterways, and the Green Energy Corridor Project for solar power. The Green Energy Corridor Project alone is a Rs 50,000 crore opportunity over 3-4 years and will enable a quick restart for PGCIL and works related to the transmission line, substations, and related EPC and equipment.
Pharma companies focused on domestic markets will continue to be preferred over USFDA driven fears (read: peers). However, after a long 5-6 years of pain with the USFDA, the quality of observations are more related to recording of standard operating procedures gradually rather than technical, which augurs well for Indian pharma companies focused on regulated markets. Indian pharma companies are gradually aligning to global standards, which is again a long-term investment opportunity in beaten-down valuations. Overall, one can expect 2020 (FY21) to be an interesting year to look forward to. The base is set for things to move ahead at a faster pace.
(The author is Head – Institutional Equities at IndiaNivesh. The views expressed are the author’s own)