May 24, 2017

Goods and Services Tax (GST) July 1, 2017 – Rollout target meeting reality

Impact on inflation, negated; anti–profiteering clause shines The conclusion of the fourteenth Goods and Services Tax (GST) Council meet paved the way for the most awaited reform to get closer to reality with rates of most products being finalised. All products and services will be taxed at either 5%, 12% 18% or 28%. Approximately 19% goods are being taxed at 28%, 43% goods fall in the 18% slab, 17% will attract 12% rate while last 14% are in the 5% slab and balance 7% are out of GST. All services will be taxed at 18% vs. the current rate of 15% while about 40% of the CPI basket is exempt from GST. The decision on GST rates depicts the government’s strong intention to roll out GST by July 1, 2017 as stated. We believe it will be a big boost for corporates as it will bring a level playing field vis-à-vis the unorganised industry by reducing the possibility of tax evasion. It should add significant revenues to the government’s kitty with an expected widening of the tax base. Given that 81% of items are to be taxed below the 18% standard rate, we believe implementation of GST is not expected to be inflationary in nature. Items whose rates have not been decided by the council so far are gold, textile, agricultural implements, bidis, footwear and bio-diesel. Impact on sectors FMCG and consumer durables being the largest beneficiary, other key sectors to benefit include, tourism, aviation, DTH cable, lubricants, laminates under building materials. A negative impact is seen on sectors like luxury hotels, theme parks, luggage, breweries and distilleries, upstream and downstream oil sector. Majority of large sectors like auto, cement, banking, agri chemicals, power and pharma are expected to witness a neutral impact.

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Impact on inflation negated; anti–profiteering clause shines •Input tax credit remains one of the major advantage under GST. However, practical implementation of input tax credit refunds and its eligibility and dispute handling will be a big task. Anti-profiteering clause warrants companies to pass on the tax cuts and gains from input tax credit to consumers in the form of lower prices. Hence, if tax cuts are passed on along with success of input tax credit, various goods may see lower prices and GST may also turn inflation friendly. •The Union government has allowed multiple rates to enable the GST Council to juggle around items to bring them under slabs that would help rein in inflation. Along with this, the provision on penal action against businesses and traders indulging in profiteering, in the wake of the GST rollout, the Union government’s primary focus has become clearer. The government wants to roll out a tax reform like the GST but not at the cost of inflation. •It has been observed that GST rates have been tweaked to encourage investments in the economy. Items in the capital goods sector have been placed under the 18% duty slab, which essentially means 10% lower than the existing rate of~28%. This, along with the duty setoff that the manufacturers can claim on taxes they pay on raw materials and components, would result in a substantial benefit. •Goods and services like petrochemicals, healthcare, education and housing are either not included or exist at 0% in GST with a possibility of being taxed in future. Alcohol is fully excluded under GST. •We have sectorally analysed the impact. Certain stocks have already started reacting to the newsflow however, the real impact can only be gauged post implementation as to how the mechanism works and tax credits are received. Further pass on of lower tax will be key and has to be monitored. This will entail use of huge work force by the government. Largely, corporates are positive on GST and are ready for implementation. However, the IT infrastructure and other operational hurdles may marginally impact the process. 3

Key benefits expected to pan out on GST implementation •To provide enabling environment for businesses - “Make in India by making one India”: Ease of doing Business

•Unorganised segment set to come under tax net •Goods transportation set to become more efficient, cheaper •To promote efficiency by providing buoyancy to tax base •To enable improvement in India’s tax to GDP ratio

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Sectoral Impact Sector

Segment/ Products

Tax rate earlier li

GST Rate

View

Positive/ Negative Stocks impacted

FMCG

Toothpaste, Hair Oil Soaps Oil,

Detergent

Edible Oil

3-9%

5%

With the reduction in indirect tax incidence, the company is required to pass on the benefit due to the anti-profiteering clause. However, we believe a price reduction is likely to result in an increase in consumer demand, which, in turn, would result in a positive impact on volume gro th growth Indirect tax incidence has increased to 28% against the industry expectation of 18%. Companies are required to increase prices to pass on the increase in taxes Tax incidence on edible oil has remained neutral for companies. However, keeping coconut oil in the definition of edible oil has been a relief for Marico

24%-27%

28%

GST rate for paint/varnishes have been kept at 28%, which is approximately similar to the previous tax slab

Positive

15% 22%

12% 12%

To promote the use of efficient lighting products, the GST rate on LED has been kept at 12%

Positive

23 24% 23-24%

23-24%

18%

28%

Colagte, HUL, Dabur, Marico, ITC

Positi e Positive HUL, Jyothy Lab Negative Marico Positive

Consumer Discretionary

Paints LED -Lamps Lamps -Fixtures

Air cooler

26%

18%

Air conditioner

26%

28%

Wires & Cables/Switches

PVC pipes/Furniture

18%

18%/28

Source: cbec.gov.in, ICICIdirect.com Research

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28%

18%/28%

The air cooler category has been kept under the 18% bracket, which will benefit organised players in terms of a shift in demand from unorganised categories (still 75% unorganised) As expected GST rate for Air conditioner have been subsumed in the 28% ((nearest slab)) Higher tax slab for wire & cable and switches would see an increase in prices of products as companies are likely to pass on to end customers GST rates for PVC pipes and furniture categories have been subsumed in the nearest tax bracket of 18% and 28%, respectively. We believe this would lead to a shift in demand from unorganised players to the organised industry

Asian Paints, Kansai Nerolac

Havells India, Electricals

Bajaj

Symphony, Bajaj Electricals Positive Voltas, Havells Neutral V-Guard, Havells India Neutral Supreme Industries, Wimplast, Prima Plastic Positive

Sectoral Impact Sector

Segment/ Products

Tax rate earlier

GST Rate

View

Positive/ Negative Stocks impacted

Financials

Banks

Insurance

15% (including Swachh Bharat Cess) 15% (including Swachh Bharat Cess)

18%

18%

Fee based services will get expensive for customers to the extent of variation in GST over current service tax rate. No material impact seen on banks Premium will increase for insurance policies - both life and non-life. Modalities in terms of taxation on life insurance policies needs to be seen

Neutral

Neutral

Multiplex

Entertainment F&B

27% on ATP 13%

On ticketing revenues, companies were expecting the tax rate to be in the range of 18%. The current rate, though higher than expectations, is neutral from the current scenario of 27%. On the F&B side, though rates are higher than the F&B VAT rate of 12.5%, the company will be able to avail input tax credit paid on the raw materials leading to benefits to the tune of 100-150 bps (against initial expectation of 25028% on ATP 300 bps expansion) 18%

PVR, Inox Leisure

Neutral Neutral

Pharma & Heathcare

API Formulation Life saving drugs

Healthcare

18% 10-11% 0 Service tax: 0% VAT: 5-12%

18% 12% 5%

The overall sectoral impact remains neutral. However, as per the management commentary, in the short-term, a negative impact of 45% would be visible on the domestic formulations front due to the downsizing of inventory at the dealer/pharmacy level over concerns on availing credit on their closing stock a day before implementation of GST

NA

Neutral Neutral Neutral

The overall sectoral impact remains neutral 0%

NA Neutral

Cement

26-27% Source: cbec.gov.in, ICICIdirect.com Research

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28%

The new GST tax rate is 1-2% higher than the current prevailing rate for cement companies. However, considering improved demand outlook, we believe cement companies will be able pass on the additional tax levy by taking price hikes

Neutral

Sectoral Impact Sector

Segment/ Products

Tax rate earlier

GST Rate

View

Positive/ Negative Stocks impacted

Hotels, Aviation and others

Luxury Hotel Transport of passenger by air in other economy class (business class) Transport of passenger by air in economy class

Aviation

Tour operator

Theme parks

21-24%

28%

9%

12%

Luxury hotel (defined as charging tariffs in excess of | 5000) were subject to multiple tax rate like luxury tax (varies across states), VAT and service tax. Under the new regime, all these taxes will be subsumed into one tax (GST). The single tax rate will result in lower admin cost. However, the new GST rate recommended for luxury hotels is significantly higher than the prevailing rate, which will negatively impact margins of hotel companies Business class tickets are not price sensitive. Hence, we believe the incremental tax will be passed on to consumers

Taj GVK, IHCL and EIH

Negative

Neutral The lower tax rate will be passed on to consumers, which may result in incremental demand for airline companies

6%

5%

Jet Airways, Interglobe aviation and Spicejet Marginally positive

5%

The lower tax rate will result in lower pricing for products, which, in turn, will boost demand

28%

Theme park operators are subject to entertainment and service tax, which vary from 18-36% depending on entertainment tax levied by a particular state, which vary from 1.5% to 20.0%. Wonderla Holidays pays average tax of 24.0%. Under the new regime, Wonderla will have to shell out higher taxes negatively impacting its margins

Negative

12%

5%

Reduction in tax rate for coal will benefit user industries like steel, aluminium, etc

Positive

18-19%

18%

The current incidence of indirect taxes is similar to the newly announced GST rates, so no major impact

Neutral

9%

18-36%

Cox & Kings Positive Wonderla Holidays

Coal

Steel

Source: cbec.gov.in, ICICIdirect.com Research

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Sectoral Impact Sector

Segment/ Products

Tax rate earlier

GST Rate

View

Positive/ Negative Stocks impacted

Auto

2-W Small car/SUV (Length<4 m; engine size<1200 cc/1500 cc for petrol/diesel vehicles) Sedan/SUV (length> 4 m;engine size< 1500 cc) Sedan/SUV (length> 4 m with engine size>1500 cc) CV Tractors

24%

24%

28%

The price of 2-Ws<350 cc will increase marginally by 0.5%. Given that there is a cess of 3% on motorcycles>350cc, the price increase post GST will by 2.6%. However, motorcycle above 350 cc contributes only 0.4% of the domestic 2-W sales Although the gap between current tax incidence & GST appears optically high, prices of these vehicles will increase in the range of ~13% post GST implementation, because the base (ex-showroom price) will also change with GST implementation. This potential price increase will not have an impact on demand

29-31%

Bajaj Auto, Hero MotoCorp, Eicher Motors Neutral Maruti, Tata Motors

Neutral Prices of these vehicles will increase ~6%. Prices of cars like Ciaz & Ertiga fall in this segment, which form ~9% of Maruti's domestic sales

32%

43%

Maruti

Negative Prices of these vehicles will increase ~0.5%. There will not be an negative impact on demand due to the potential price rise

36% 24% 12%

43% 28% 12%

Tata Motors

Neutral Prices of these vehicles will increase ~0.5%. Hence, the impact will be neutral Prices of tractors will reduce ~1%

Neutral Neutral

Tata Motors, Ashok Leyland, Eicher Motors

Real Estate & Building material

The impact of the new GST rate would vary for different micro markets in which developers operate. The Bengaluru market would be least impacted as the current incidence is also around ~11.5%. Furthermore, for markets like Maharashtra, the current incidence is around 5.5%. Though developers would be receiving input credit on raw materials and labour, the new rate would be slightly negative for them Real Estate Tiles Plywood

Laminates

5-12% 26.5-29%

28%

27-29%

28%

27-29%

Source: cbec.gov.in, ICICIdirect.com Research

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12%

18%

Oberoi Realty

Marginally negative The current incidence of indirect taxes is similar to the newly announced GST rates, so no major impact The current incidence of indirect taxes is similar to the newly announced GST rates, so no major impact The newly announced GST rates for decorative laminates is much lower than the current incidence, which is positive for laminate players

Neutral

Kajaria Ceramics, Somany Ceramics Century Plyboard, Greenply

Neutral Century Plyboard Positive

Sectoral Impact Sector

Segment/ Products

Tax rate earlier

GST Rate

View

Positive/ Negative Stocks impacted

Bags & Luggage

18%-19%

28%

Since the proposed GST rate is higher than the existing tax rate (1819%), we believe it may dent the profitability of players in the shortterm. However, over the longer term, organised players may take a gradual price hike to partially negate the impact on margins

VIP Industries, Industries

Safari

Negative

Logistics

Road transport Rail & Coastal shipping

Container Rail Express, Warehousing & other value added services

4.5-6%

4.5-6%

6%

5%

5%

Freight rates across modes of transport are expected to remain at earlier levels. However, input tax credit for road is not allowed to promote movement of goods from rail and coastal. Still, we continue to believe that road transport would continue to play a pivotal role to execute last mile delivery. In addition to the same, introduction of eway bill would enable seamless movement of goods resulting in cost savings, improving vehicle efficiency Rates maintained at earlier levels. However, input tax credit, excluding capex, is allowed. This would bring in effective tax rate lower or close to existing rates Higher taxes coupled with elevated haulage charges would impact the competitive positioning of rail vis-à-vis road. Any input credit allowed in the sector would provide a breather. The market leader would be able to pass on the hike in rates thereby maintaining the realisations

12%

15%

18%

Malt

22-24%

28%

Glass

5-6%

12-18%

TCI

Positive GPPL Positive Container corporation

Neutral Given the recent hike in service tax rates to 14%, the industry was prepared for 18% service tax in FY18. However, the shift to organised would trigger volume growth, which would benefit players having a pan-India presence

Gati and Bluedart

Positive

Breweries & Distilleries

Source: cbec.gov.in, ICICIdirect.com Research

9

Malt remains a key raw material for preparing beer. The increase in RM material prices would impact the margins of the business Bottling and other packaging expenses form ~25% of overall revenues, which would further increase on the back of higher taxes

Negative Negative

United Breweries & United Spirits United Breweries & United Spirits

Sectoral Impact Sector

Segment/ Products

Tax rate earlier

GST Rate

18%

18%

0% 2% flat rate with no input credit

0%

View

Positive/ Negative Stocks impacted

Agri & Chemicals

Agro Chemicals Seeds

Pen & Pencils Technical Textiles (FIBC's) Industrial Chemicals (Textile Chemicals)

Tractors Chemicals (Carbon Black)

Central excise duty of 12% + VAT of ~6% was already in place; no material impact Seeds were always exempt from any taxes including excise duty; they will continue with nil tax structure Writing instrument players will now be able to avail the input credit; net effect is neutral

12%

18%

18%

18%

18%

Rallis India Neutral Rallis India Neutral Linc Pen & Plastics Neutral

Central excise duty of 12% + VAT of ~5-6% was already in place; no material impact GST helps their end customers avail MODVAT credit; to help increase the share of organized players

Neutral

Emmbi Industries; Kanpur Plastipack Shree Pushkar Chemicals

Positive

0% rate with no input credit

12%

17.5-19%

18%

Rate of 12% is a revenue neutral one for tractor industry. Now they will be able to avail input credit (28% GST rate on inputs); net effect is neutral Rate of 18% will be a revenue neutral rate for the industry given the mix of domestic procurement vs. imports

NA

Oil companies in earlier tax regime claimed input tax credit against excise duty and VAT on crude oil, petrol and diesel. Under the new GST tax regime, the oil companies will be unable to claim input tax/GST paid on procurement of plant, machinery and services as majority of its products like crude oil, petrol, diesel and jet fuel are excluded from GST rate structure, which will have an impact on profitability. However, a portion of input tax can be claimed against products like PDS-kerosene, LPG and naphtha, which come under GST

VST Tillers & Tractors Neutral Phillips Carbon Black Neutral

Oli & Gas

Upstream and downstream oil sector

NA LPG, Kerosene: 0%-Excise duty, 0-5% VAT (stateDownstream sector wise)

Lubricants

24-28%

Source: cbec.gov.in, ICICIdirect.com Research

10

VAT on PDS-kerosene and LPG earlier was in the range of 0-5% varying from state to state with nil excise duty. The new GST rate of 5% will increase PDS-kerosene and LPG prices in some states where VAT was lower than 5%. Overall, the impact remains neutral as additional 5% tax shall be passed on to customers 18% for the This move will be positive for the lubricant sector as we believe the majority of companies will be able to retain a portion of the tax savings. This will the products result in increased profitability

ONGC, IOC, BPCL, HPCL, MRPL

Negative IOC, BPCL, HPCL

Neutral Castrol India, Lubricants Positive

Gulf

oil

Sectoral Impact Sector

Segment/ Products

Tax rate earlier

GST Rate

View

Positive/ Negative

Stocks impacted

Power & Capital Goods

Coal EPC/constrcution work Contract

11% 15-20%

Transformers

18%

Update on GST : Sector - Consumer

Source: cbec.gov.in, ICICIdirect.com Research

11

5% 12%

28%

Lowering of GST rate on coal will be beneficial to private IPPs who operate on merchant rate model and competitive bid based model. On the other hand, the move will be neutral for regulated utilities for which the tax benefit will be a pass through in the form of lower tariffs to beneficiaries The decline in GST rates to 12% from the current 15-20% will be beneficial for EPC/constrcution based companies The move will entail all the transformer companies to take price hikes which will be negative in a scenario wherein demand is still about to recover and competitive intensity is high, especially in low voltage segment

Regulated Utilities like NTPC, state owned gencos and private IPP's Neutral L&T Positive Transformer sector

Negative

Pankaj Pandey

Head – Research

[email protected]

ICICIdirect.com Research Desk, ICICI Securities Limited, 1st Floor, Akruti Trade Centre, Road No 7, MIDC Andheri (East) Mumbai – 400 093 [email protected]

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