The GST Windfall

On July 1, last year, the complicated web of indirect taxes was replaced by the Good and Services Tax (GST). The introduction of new tax regime was a contributing factor to positive investor sentiment as organised businesses including listed companies were expected to gain from GST. Stock prices soared, factoring in the effects of the new tax regulation.

One year on, while few small- and mid-caps are showing early signs of benefiting from the most significant tax reform since independence, some are still awaiting the gains of the new tax regime. As the disruption caused by the reform recedes, small benefits are becoming visible, according to analysts. “The shift towards the organised sector is already visible in GST-themed stocks. Stock prices will rebound once the growth comes back,” says Abhimanyu Sofat, head, research, IIFL Securities. 

Pointing out to demonetisation and implementation of GST and e-way bills, Mahesh Patil, co-chief investment officer, Aditya Birla Sun Life Mutual Fund says that the organised sector will benefit from these reforms. Looking to grab the opportunity provided by the implementation of GST, several AMCs launched a fund last year comprising stocks that will benefit from the new tax regime over the next three years. “Companies who are able to manage the uncertainty in the interim, without losing sight of the broader opportunity, will eventually succeed. The current market correction provides good opportunity to buy mid- and small-cap stocks,” says Patil.

Getting more organised

During the GST rollout, the shift towards the organised sector was projected as one of the biggest investment themes. In 2016, after the date for the implementation of GST was announced, mid- and small-caps in plywood, plastic and retail had rallied. The unorganised players have a significant presence in these sectors. Hence, the listed companies in these sectors were expected to gain big market share due to the tax overhaul. Analysts believe in the shift towards organised, companies such as Century Plyboards, Greenply Industries, Future Retail and Supreme Industries will be the major beneficiaries.

In the plastic segment, Pankaj Pandey, head, research, ICICI Direct is banking on Supreme Industries. The company is one of the biggest manufacturers of polyvinyl chloride (PVC) pipes and operates in a segment dominated by unorganised players. Analysts think that the implementation of GST has helped to reduce the price difference between unorganised and organised players in the plastic industry due to uniformity in taxation. “As a result of this, unorganised players would either have to hike their price to maintain their current margin or take a hit to their financials by not passing on higher prices to customers, which is unsustainable in the long run,” says Pandey. 

As the unorganised players find it unviable to operate outside the GST bracket, the shift towards organised sector is expected to intensify. Highlighting Supreme Industries’ move to expand its capacity from 565,000 tonne to 700,000 tonne by 2020, Pandey says that it is best placed to gain market share from the unorganised sector.

Deepak Jasani, head, retail research, HDFC Securities says that while plastic products manufacturers have benefited from the shift to the organised sector, other sectors such as tiles, laminates and plywood have not seen meaningful impact as yet. “The reason for the slow change in some sectors is the flourishing unorganised trade due to lack of anti-evasion measures. A lot would depend on strict surveillance and rollout of anti-evasion measures,” says Jasani.

But with the GST Council making e-way bills mandatory for inter-state movement of goods from April 1, these sectors are also expected to gain as under-reporting of sales and tax evasion would be now difficult for unorganised players. “The unorganised players would resort to better compliance, which would create a level playing field in terms of pricing for organised players,” says Pandey. As the difference in pricing shrinks, Greenply Industries and Century Plywood are expected to capture the incremental opportunity arising from the consolidation of unorganised players. 

According to Nitasha Shankar, senior vice president, research, Yes Securities, lowering of GST rate to 18% coupled with government’s focus on affordable housing puts Century Plywood in a strong position in the wood panel segment. “We expect the company to post volume and revenue CAGR of 28% and 34% respectively over the next three years due to higher operating costs for unorganised players post GST and increasing brand awareness,” Shankar says. 

The company’s laminates business registered strong volume growth of 17% in Q4FY18 (YoY). “There is a large unorganised market in laminates. The company’s increased focus on laminates and lower GST rate will help it gain market share in this segment,” adds Sofat. 

As the share of the organised market is set to expand, analysts have also picked Greenply Industries, which is also a major player in plywood and medium-density fibreboard segments, to be a principal post-GST beneficiary. The company’s decision to invest Rs.3.60 billion in FY18 for expansion and its plan to set aside Rs.1.50 billion for capex in FY19 could catapult it into a leading position to gain market share. 

Even established players such as Future Retail are touted to benefit. According to analysts, it has become more difficult for unorganised wholesalers to do business, leading to market share gains for organised modern trade players (see: Ground reality). “The unorganised segment is not yet out of the woods after the GST and demonetisation shock, which will continue to help organised players such as Future Retail going forward,” says Shankar. 

But even as the shift towards the organised sector has begun, the full benefits of the GST are expected to be visible only in the coming years. Post the general elections in 2019, the government is also expected to push for strict enforcement that will further help the organised players. 

Selling out fast 

The retail sector is not only expected to benefit from shrinking of the unorganised segment but also from new taxation rules. Retail companies can now take advantage of lower tax rate and claim input tax credit on operating expenses.

One of the mid-caps in the retail segment that has benefited the most from lower tax slab is V-Mart Retail. The implementation of GST has given an edge to the company over its peers. As around 85% of its the revenue comes from products priced below Rs.1,000, a lower GST rate of 5% is applicable on them instead of 12%. 

After the implementation of GST in July, 2017, its stock price jumped 159% from Rs.1,199 to reach a high of Rs.3,105 in July, 2018. The market has since corrected and it is currently trading at Rs.2,410. The company has also reported robust numbers with sales growing 22% and PAT increasing by 77% in FY18. 

“Earlier, companies were not getting credit for the taxes paid. Now under GST, we can claim credit for taxes. We have passed it back to the consumers but overall, it has resulted in cost reduction for us,” says Anand Agarwal, chief financial officer, V-Mart. With the company being able to claim input credit tax and pass the benefits to customers, volume has increased by 15%, while the average selling price has come down by 3% in FY18.

Pandey of ICICI Direct prefers Bata and Trent in the retail segment. He expects their revenue to grow owing to the rationalisation of taxes. “We believe companies such as Bata and Trent will be major beneficiaries with estimated revenue growth of 15% and 20% respectively between FY18 and FY20,” says Pandey.

Analysts are of the opinion that the new GST regulation not only leads to saving of taxes for a retailer but also reduces the cascading effect. “If the overall incidence of tax is lower than previous tax regime, then the same can be passed on to the consumer, which could enable the companies to spur volume growth and capture market share from unorganised players,” says Pandey.

Long-haul ride

The implementation of GST has also made the movement of goods faster and has reduced the number of warehouses used by retail players. “The single warehouse model will be extremely beneficial for consumer-oriented companies. It will reduce expenses as the companies won’t need to have warehouses in each state,” says Harendra Kumar, head, institutional equities, Elara Capital. 

As the economy heads towards formalisation with the consolidation of warehouses, India’s logistics sector will also undergo significant change. FMCG and auto companies have been maintaining a warehouse in each state due to the existence of multiple state VATs. However, with one unifying tax replacing various indirect taxes, there will be a fall in the number of warehouses. 

That drop will be beneficial for organised logistics players. Warehousing consolidation due to the removal of tax arbitrage at state-level would lead to longer distance trips for road transportation companies, providing impetus to revenue growth. Pandey is betting on TCI Express to gain from structural change brought about by GST. “Pick-up in manufacturing activity, and shift of market share in favour of organised players who are more tax-compliant would enhance volume growth for players such as TCI Express,” adds Pandey.

Even as they see benefits of GST translating into growth for companies, analysts and fund managers are advising investors to be selective in picking the right company while betting on GST. “The entire space (mid- and small-cap) has corrected but eventually companies with strong competitive advantage either having a strong brand; the lowest cost of production or strong distribution will eventually emerge as a leader,” cautions Patil.