Blogs from Our Experts | May 26, 2017
Biggest transformation due to GST in our country will be formalization of the economy.
Nifty went up by 18.54% in just concluded financial year 2016-17 (FY17). Beyond this headline number there were two key trends for market this year. 1-Most of the market gains came in the last quarter of the financial year. Nifty was up just by 2% (7738 to 7893) in the first nine months of the financial year and all the rest gains (16%+, 7893 to 9173) came during last three months. 2- While Nifty was up just by 16.54%, other indices notched up even higher gains. NIFTY Mid Cap Index grew by 34.85% and BSE Small grew by whopping 36.93% during the last fiscal year.
This higher gains by small cap stocks can also be seen from the fact that out of 775 stocks in the BSE small cap index, 86 surged for more than 100%, 167 gained by 50% to 100% and 312 gained up to 50%. So, it is fair to say that FY2016-17 was an unusually good year for small caps. What explains this huge out-performance by small cap stocks? Whereas out-performance of small cap during 2014 to 2016 was primarily due to small caps being traded at large discounts to large cap stocks in 2013, out-performance of small cap stocks during 2016-17 is all due to implementation of GST this year. Biggest transformation due to GST in our country will be formalisation of the economy. Small and micro cap companies face maximum challenges from the unorganized sector as the latter primarily operate on a small scale and rely mainly on the cash transaction. Not only so, flouting regulations, manipulating accounts, evading taxes, and going scot-free are the permanent features of these unorganized players. So any tightening of norms for these un-organized players are positive for listed small and micro cap companies.
In fact, the biggest structural story unfolding in the Indian markets is the value migration from the un-organized to organized sector. As liberalisation took the wind away from PSUs to the private sector, the formalisation of the economy will boost the prospects of listed small-cap businesses at the cost of unorganized players. Twenty-six years ago, in the year 1991, the Indian economy had witnessed a massive structural shift when the country had adopted a new economic policy marked by liberalisation and privatisation. Since then, the BSE Sensex increased by fifteen times and a lot of private listed companies went on a day run. Some of these stocks are now part of the Sensex and have witnessed 443 times (HDFC Bank Ltd.) and 931 times (Lupin Ltd.) gains respectively. GST to our mind will have a similar strong impact on our economy going forward. Indian business scenario pre-1991 and post-1991 was dramatically different and now Indian business scenario pre-GST and post GST will again be very different.
GST will make the tax collection easier and transparent; it will bring in homogeneity, benefits of input tax credit entitlement, and also hassle-free tax compliance due to an abolition of multiple tax laws. It will further reduce the overall tax rates by ensuring the availability of seamless input credit and tracking the flow of GST credit in the entire value chain with the use of advanced technology platforms. Facilitating bilateral validation of invoices, GST will also eliminate the inputs claimed on fake/paper invoices and shall also eradicate duplication of claims for input tax credit by more than one entity. This indeed will go a long way in addressing the loopholes in tax administration. Common formats for returns and payments combined with electronic filing/payment and standardised PAN-based registration will ensure data consistency.
Going forward, GST will pave the way for listed small-cap companies to go on a smooth ride in terms of their business. A lack of compliance with GST will increase the working capital needs of SMEs. On the other hand, listed compliant firms will enjoy a cost advantage due to tax efficiencies.
The sectors with large % of unorganized players are expected to be big beneficiaries:
In Homebuilding sector (Paints: 35%, Adhesive-30%, Plywood-65% & Tiles-49%); In Consumers (Footwear-60%, Garments-innerwear-48%, Apparel-73%, Plastic-40%, Luggage-67%); In Light Electricals (Fans : 25%, Pumps-30%, Air coolers-80%, Domestic Switchgear-5%, Industrial switchgear-25% , Modular Switches-40%; Domestic Wires and Cables-20%, Industrial Cables-40%, Electrical Lighting-40% ); In Healthcare (Diagnostic-85%, Hospitals-90%); In Logistics (Logistics-Road-95%); In Auto Ancillaries (Batteries-35%, Tyre-20%); In Metals (10%); In FMCG (Biscuits-35%, Hair Oil-50%, Beverages-50%, Dairy-80%, Detergents-20%, Tea and Coffee-50%).
But one must keep track of risks in investing on this current theme. Our belief of transformational ability of GST should not make one go reckless about investing in so called GST favoring companies. There is a saying in professional trader’s community- ‘buy on rumors and sell on news’. And fundamentally, most of these small and micro cap companies in historical sense are trading at very high valuation now. P/E of BSE small cap index on trailing twelve months earning basis is 68 and that is alarming. So, while we believe that GST implementation will transform the economy, will particularly benefit listed small cap and micro cap companies but due to already lofty valuation, we advice rigorous fundamental analysis and strict risk control while investing in popular ‘GST stocks’.