GST won’t affect profitability in medium to long term: Sanjeev Prasad, Kotak Institutional Equities

GST won’t affect profitability in medium to long term: Sanjeev Prasad, Kotak Institutional Equities

Jet may have put a cost reduction plan in place and are looking at 19% to 20% EBITDA level by 2020. Do you think the preference would continue to be with the low-cost domestic carriers with a higher dominant market share in the domestic market as of now?

We only cover IndiGo. I really cannot comment on the specifics of Jet or SpiceJet but having said that, we do like IndiGo. This is a good sector to own because it is a very good play on the entire consumer discretionary space. If you really look at the competition with railways, in the long term, in the long distance passenger transport market it makes so much sense rather than use railways.
Given the fact that if you look at the price difference between AC two tier railways, buses and economy class ticket, if you book it slightly in advance, the prices are not very different. It should make enormous sense to actually take a flight than go in a train for 24 to 48 hours given the distances in the country.

Second, the industry structure is nicely concentrated among top four players. IndiGo has 40% market share and the other three are at about 13% to 17% each. It looks like the third and fourth players which are Jet and Air India are focussing on improving the balance sheets which is a great thing because one of the things which has hurt the sector historically has been irrational competition from time to time. It does not look that is going to be the case. Maybe the profitability of the sector should look up as we go forward and as of now it is also quite fine.

There is always some concern that because of crude prices going up, profitability could be impacted. But if the industry itself is taking a call towards higher profitability, there is no reason for anybody to do anything irrational. Any sort of cost increase will be passed on to the consumers and it is not a big deal. All put together, we like IndiGo given all the structural factors highlighted.

Do you think it is high time we look at the entire India consumption space very differently. The first port of call is that you buy staples, you look at consumer discretionary but now should one look at pockets like aviation, data consumption because ultimately they are also bets on India demographics?

Absolutely correct. Ultimately you have several choices when you are looking at the entire consumption basket. As you rightly said you have the well known staples, the discretionaries, you have other forms of consumption and you also have financing of consumption. So far, the focus has been obviously on the well known names in the consumer staples and discretionary basket and the private retail banks as the way to play the demographics or the consumption story. But at this point in time, as income levels increase and the purchasing power improves, incrementally people at the lower end will move up to consume other forms of staples but I guess people at the higher levels in terms of incomes will probably move to much more discretionary forms of consumption which includes basically travel, tourism. The consumption basket as we go forward will evolve more towards discretionary items.

Having said that, obviously India is such a vast country with effectively 100 million people. Every 10% of the population is a mid-sized country basically.

I think there is growth everywhere not just in staples, discretionary, but across the board. So, you pick and choose what you are comfortable with in terms of valuations and how you want to play the entire consumption story.

How are you looking at the impact of GST on how businesses have managed to regale through the transition in terms of how that influences the earnings trajectory. What are you factoring in lieu of the GST adjustment this year for not only FY18 but also FY19 onwards?

See GST is obviously a temporary phase in terms of disruption to the economy, The larger companies are pretty much unimpacted in terms of handling the whole GST issue. The large companies are very well prepared for it and they have smoothly navigated the entire GST transition. I do not see any real disruption there.

Obviously, there is disruption in the smaller companies. So, applying the whole process is somewhat complicated compared to how they have done business earlier. They will take some time to get in terms with GST and it will take probably two, three, four quarters but I assume over the next two-three quarters, things would settle down as far as the impact of GST is concerned.

As far as any one off or a tax related impact is concerned, honestly there should not be much of an impact because it is an indirect form of taxation which logically should get passed on to the consumers.

But having said that, we have not seen that to the full extent as yet which in a way shows the pricing power of the companies in India. If you look at the second quarter, there seems to be a fair bit of an improvement in the margins across the board and I guess one way to look at it is may be the companies benefiting from all the input tax credit which they got which they not really passed on in the form of a price cut to the consumer.

They have done alignment more on the tax side on the finished product. That is matching the tax under GST versus whatever there was earlier and made adjustment accordingly but I am not very sure whether any benefits coming out of input tax credit has been passed on to the consumer.

Also there were other forms of taxes which no longer exist. There was again some benefit coming because of that but that was a onetime benefit that can be seen in the second quarter you numbers. You see a decent increase in EBITDA margin for many of the staple discretionary companies which means that they have benefited.

I do not really think GST matters in terms of companies’ profitability in the medium to long term. That will depend more on the company dynamics in every industry and how the company is positioned in various sectors.

The other big sector move this morning has been logistics after them getting the infra status. Funding and borrowing would be easier. The fact is this is going to aid external trades as well. Is that a segment that you are looking at all and if so where is it that you would be bullish?

Honestly, there are too many companies to play this the segment. I do not know what you can really buy in terms of large logistics companies etc. Over a period of time you will see a fair amount of consolidation in this business. Because of the implementation of GST, a number of smaller truck operators will probably get consolidated into larger truck operators. So, I see the whole industry revolving around large national logistics operators. But we have not seen that thing evolving as yet. There are few names here and there.

If some of these companies are smart and able to scale up, you could actually see the evolution of pretty large companies as we go forward. One thing is pretty clear — the segment in nature of this industry is not going to exist in the next three to five year timeframe. What we are seeing in just about every sector in terms of formalisation of sectors which had a very large informal component that is getting formalised going forward.

It will become a very interesting, very important sector going forward but as of now we just struggle to find any names of reasonable market cap over here.

You are rather sounding sunny to me, that is very unlike you. You have always raised a red flag. It tells me that you are rather constructive about earnings?

That is correct because obviously we were negative at a time when there was no earnings. So that is fine. At least we are seeing some visibility on earvisibility on earnings. I do have a right to be a bit more positive.

Do you think the kind of earnings trajectory we have seen in Q2 is a trend in making and not a one-off? Frankly, there were so many moving parts for the quarter gone by that it is very difficult for us to really extrapolate that into a trend?

That is correct. I am not really basing my bullishness on the second quarter numbers. This is as far as the earnings go, valuations is a separate matter altogether. If you look at earnings across sectors, they seem to be bottoming out or have bottomed out over the last two three years.

We have seen many sectors getting impacted because of one reason or the other. For example, in automobiles, you should see a reasonable recovery in profits in 2019 versus the current year for the simple reason you will get much lower hedge losses for Tata Motors as we go forward. We are looking at a big increase in profitability or rather profits for Tata Motors in 2019 and 2020 as the hedge losses unwind.

If you look at the banking sector, last two years have been disastrous for the public sector banks and even some of the private banks like Axis and ICICI because of huge loan loss provision they had to make as part of the NPL recognition.

Our view is that most of the recognition is already done, GNPLs and NPLs are peaking out, slippages are coming off and as we head into fiscal 2019, you would start seeing the loan loss provision numbers also starting to come down which effectively means you will see a big increase in the profit numbers of several banks whose earnings numbers have got decimated over the last couple of years. So, that is another sector where we are seeing a big earnings improvement.

Of course, this will depend on the extent of resolution but now given the recap programme announced by the government for the PSU banks, the fact that many of the cases before the NCLT will close by March to June timeframe because many of the cases were referred to the NCLT in August, in nine months anyway you have to have a decision.

I am hopeful that many of these cases would not see the kind of huge losses given by default which we expected at one point of time. The steel cycle has improved, there is interest among buyers over there and so the loss, given demand numbers, could probably be a lot lower than what the earlier assumptions were.

If you look at the commodity basket which is metal and mine, mining and oil and gas, given the fact that you are seeing a good rally in commodity prices and structurally there seems to be improvement in supply demand balance across most of the industries, there is a lot of growth in some of the commodity vectors and that is one more reason why you are seeing a decent earnings growth in 2019 over 2018.

Lastly, in some of the sectors which had sector specific issues such as pharma and telecom, the second quarter numbers suggest that maybe we are getting to end as far as the bottoming out of numbers are concerned.

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