HUL and ITC have the leanest distributor inventory and lower wholesale salience, and should be less impacted.
The GST will lead to a down-stocking in Q1FY18, which will not fully reverse in Q2. Closing stock for the FMCG sector on June 30 will suffer a loss under the GST transition rules of 60% presumptive credit by 4-7% on paid taxes, and thus we expect a destocking. This may not fully reverse post-GST as companies may take this opportunity to make the pipeline leaner. Companies will compensate distributors, but will also advice reducing stock. While companies are willing to compensate distributors for the loss on closing stock, they will limit their cost by reducing stocks to a level which does not disrupt end-retail offtake. If closing stock is lower by 10 days, the cost goes down by 20 bps for full-year sales. Wholesalers may not necessarily down-stock pre-GST, will be impacted post-GST. Wholesalers may not necessarily down-stock in categories where they anticipate a rise in prices post-GST, to play arbitrage. Post-GST, however, wholesale will remain disrupted for a few months as they figure out ways of working.
Real growth will be hard to fathom for three quarters. Staples have 30-90 days of channel inventory and stock changes can severely skew growth. First quarter will see down-stocking, Q2 will see up-stocking but a weakness in wholesale, and in Q3, the base quarter had demonetisation. The extent of channel inventory and wholesale mix varies across companies and it will thus be hard to gauge real growth trends for the next three quarters.
ITC, HUL will be least impacted, Colgate most impacted. HUL and ITC have the leanest distributor inventory and lower wholesale salience, and should be less impacted. Colgate could be most impacted as wholesale is higher and toothpaste will see more down-stocking as prices may go down.
Trade margins too have to go up. The tax payable on trade margins is increasing from 14% currently to 18-28% under GST. Companies are likely to increase trade margins by 100-200 bps to compensate for this so that net margins remain steady.