The moot question is if FMCG firms will pass on tax cuts to consumers, which may boost demand
What happens to competitive dynamics remains to be seen if some firms pass on benefits
The government’s move to cut corporate tax rates will undoubtedly boost earnings of fast-moving consumer goods companies. Investors recognize that. After all, the Nifty FMCG index has surged 9% in the past two trading days. The moot question, however, is whether companies will pass on these benefits to consumers, in turn boosting consumption demand. Most analysts believe that FMCG companies will retain a good portion of the gains.
“We are not suggesting that we don’t see a few price reductions here and there. Such moves are unlikely to be dilutive to absolute operating profits, however. Any reinvestment will essentially be used as a ‘fuel for growth’ or ‘fuel for accelerated premiumization’, ensuring operating profit neutrality," said analysts from Kotak Institutional Equities in a report on 20 September.
“To assume otherwise (i.e. companies sharing anything more than a small portion of the benefits with the consumers or trade) would fly in the face of historical evidence in the sector," it said.
Moreover, unlike in the case of the goods and services tax, the government has not specified that companies will have to pass on the benefits to consumers. As such then, investors would do well to keep expectations a tad low on the demand improvement front, at least from a near-term perspective. This also means meaningful revenue growth is not going to happen in a hurry.
Separately, what happens to the competitive dynamics remains to be seen. “Given the differential earnings boost depending on current tax rates, it will be interesting to monitor the shift in competitive dynamics in key categories if leaders choose to pass on benefits for higher growth," wrote Varun Lohchab of Jefferies India Pvt. Ltd in a report on 22 September. “For example, Hindustan Unilever Ltd benefits in soaps versus Godrej Consumer Products Ltd (GCPL); Colgate-Palmolive (India) Ltd and HUL benefit versus Dabur India Ltd and Patanjali in toothpaste; and HUL benefits versus Procter & Gamble in laundry and shampoos," added Lohchab.
While some companies are not expected to benefit, earnings per share estimates over FY20-FY22 have increased close to 15% for some others.
For instance, Colgate-Palmolive, Nestle India Ltd and Britannia Industries Ltd are expected to get a larger earnings boost. On the other hand, earnings impact on Dabur, GCPL and Marico Ltd is expected to be limited thanks to their already lower effective tax rate.
Meanwhile, the sharp uptick in most FMCG stocks suggests investors are capturing in a good share of the positives. “Companies which could benefit from the reduced tax have already seen a rally, and a more sustained re-rating depends on companies delivering on fundamentals," pointed out SBICAP Securities Ltd.
In the near future, the upcoming September quarter results and management commentary would offer meaningful clues on the demand situation.