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Corporate tax cut can’t revive near-term consumer sentiment: Sanjay Mookim, BofML

The India equity strategist is positive on financials, industrials, cement companies among sectors.

, ET Bureau|
Updated: Oct 29, 2019, 10.20 AM IST
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Sanjay Mookim-BofAML-1200
The market seems to be expecting a tax cut that will stimulate near-term demand but there is little room for the government to do so in the current financial year, said Sanjay Mookim, India equity strategist, Bank of America Merrill Lynch. In an interview with Sanam Mirchandani, Mookim said he is positive on financials, industrials and cement companies among sectors. Excerpts:

The impact of the corporate tax rate cut was initially thought to be extensive. Do you see a major impact?
That answer depends on the timeframe that you are looking at and the context of the impact you are talking about. A corporate tax cut leaves more cash flow with companies. In theory, companies can potentially invest that money, or give dividends to shareholders, or cut margins.

In an emerging economy like India, such a measure is designed essentially to be an investment stimulus. By definition, this will take time to show up in the economy. Companies need to consider the demand environment and competition before deciding on new capex. We see three broad reinforcing effects of corporate tax cuts. First, these increase the IRR (internal rate of return) of new projects. Second, the ability of a business to undertake that project goes up as it has more cash. Third, banks are more willing to finance a corporate that has higher internal cash generation. In that respect, a corporate tax cut can be extremely effective. The medium-term trajectory of private sector capex will be higher than before the measure was announced.

I think the disconnect you point to is that the market was hoping for a measure that supports near-term consumption. Demand trends seem to be weakening in some parts of the economy. The hope among investors was for a tax cut that reverses these, but a corporate tax cut does not do that. That is where the sense of disappointment or scepticism comes in.

The festival season is on. Do you see a pickup in consumption demand?
Our channel checks so far suggest demand trends in the festive season are mixed at best. Consumption seems flat to down on a yearon-year basis. Sequentially, the festive season is lifting demand seasonally as expected. Sales on online channels are doing extremely well, we understand. Most of this seems to be coming from tier 2 and tier 3 India, rather than from urban India.

There is a concern the government has little room to announce more reforms without disturbing its financials.
Even before the corporate tax cut, there were concerns over the fiscal deficit. Revenue collections are well below projections. The government is managing by cutting expenditure. This is something they will have to continue through the rest of the year. Logically, there is no room for further tax cuts unless the government decides to increase the deficit. The market, however, seems to be keenly expecting a tax cut that stimulates near-term demand. This could be a reduction in personal income taxes or a cut in GST (goods and services tax) for some categories. Such a step seems like a very low probability to me for two reasons. First, there is little room in the FY20 budget for fresh tax cuts and second, peak seasonal sales are largely over. Consumption tax cuts would have been more effective ahead of the festive season.

You had said in a recent interview that the last time there was an EPS upgrade in a year was in 2009. What is your expectation this year?
The earnings trajectory for the market remains relatively poor. If you take the Nifty for example, our estimate for Nifty EPS for December 2020 was Rs 690 in 2018. Even after we build in the benefit of the tax cuts, that would now be Rs 640. The tax cuts have not been enough to maintain market EPS forecasts or lead to upgrades. In many cases, the problem does not lie with the companies’ ability to deliver. It is that market and analyst expectations and forecasts are just too high. We will continue to see very sharp downgrades across many companies.

The ruling party’s performance in state elections is being described as a blip by some. Do you see any impact on policy?
My belief is state election results are not going to affect equity prices in any meaningful way. The market is unlikely to extrapolate whatever has happened in state polls, whether positive or negative to central government policy action. The government seems secure until 2024. It has enough control in both houses of parliament to execute a wide range of reforms. I don’t think equity markets are going to spend too much time thinking about state elections now.

It’s been a year since the Infrastructure Leasing & Financial Services (IL&FS) crisis came to light. How much progress has the financial space made in terms of recognition of issues?
In some ways, progress has been made in the NBFC (nonbanking financial companies) space. We now know a lot more about the quality of these balance sheets than we did one year ago. Progress has been made in the case of PMC (Punjab and Maharashtra Cooperative) Bank, for example. Now we know of the problem. Acknowledgement is the first step to resolution.

There are two broad fixes to a distressed asset on a lender’s balance sheet. Either the asset itself is revived and is able to discharge its liabilities, or the lender is able to find sufficient equity to replace the value lost in the asset’s distress.

Over the next few months, troubled financial institutions will have to work along these two paths. A lot needs to be done before these companies can return to a steady state.

The market seems fearful of a credit event, in case any of these companies is unable to resolve its balance sheet issues.

What are your sector preferences?
I am not entirely convinced that there is a broad-based consumer slowdown. If you look at data outside of the autos, there is no negative volume growth number yet. Consumption in every category is still growing year on year. If you look at the run rates of volume growth at a broad range of consumer companies, they are today at their long-term averages. Sales growth seems slower particularly because last year was very strong. GST was implemented in 2017, which led to destocking across supply chains. Many businesses had come to a virtual halt. The recovery from GST meant sales numbers in 2018 were very strong. It is in the context of 2018 that the current growth numbers appear to be a deceleration. A second issue is that topline growth looks weaker as there is little inflation. Most companies are stuck with single-digit topline growth which is not something they and investors are used to.

The deceleration in sales growth seems to have created a specific, short-term problem. Our channel checks suggest inventories across many distribution chains are well above average. Companies seem to have extrapolated strength from 2018 but are now faced with more average run rates. This has driven inventory accumulation. There are only two ways this can be resolved. Either demand comes back if, say, Diwali is strong enough to clear inventory across consumer channels, or you get a period of upstream production shutdowns.
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