Did GST and Notebandi Help? Sherlock Holmes Finds Out...

Jan 13, 2018

Kunal Thanvi, Research analyst

If you are an owner of a business, you have been on the receiving end in 2017.

The government's fight against corruption (read: Notebandi) and 'one nation one tax' (read: Goods and Service Tax) has confused and scared you straight.

My family, involved in wooden handicrafts business, has faced the same heat.

A hit on cash transactions has disrupted the whole supply chain across businesses.

The demons of notebandi were barely settled somewhere in March-April, when GST implementation came to haunt us in July.

The whole year was one long struggle: de-stocking, delay in exports incentives, impact on the duty drawback, and what not.

Since my family business supplies to exporters (wooden handicrafts and furniture), the situation was even tougher with export refunds going out of shape (longer wait period).

Everybody could see tough times lay ahead. On a visit to my hometown in July last year, I had this conversation with one of my cousin:

  • Me: Hey, GST is gonna increase your compliance cost, right. Is it going to impact anything else?

    Cousin: Definitely, ya. Currently we are under 5% tax bracket, we move to 18% now. Our receivable and payable days are around 60 days each, but we need to pay GST in 30 days.

    Since we deal with big export houses, with 'n' number of suppliers we will not be able to recover the tax amount from them but will need to pay to our suppliers.

    Me: So, what you mean is you will need additional working capital while being less competitive on pricing?

    Cousin: Yes. Given the increase in working capital we are gonna face pressure on our margins.

Even though I tried explaining to him the benefits in the longer term, he just refused to buy my points.

This was in July. The situation turned out that way until September. Those three months were tough as the working capital requirement increased and there was not much clarity on the export refunds.

But after September, some interesting patterns emerged...

I went back to my home town in December. My cousin happily admitted things weren't so bad - he got nervous and took a very short-term view.

Yes. Things have improved on the ground for them. To their surprise margins and profitability have now increased by 20-30%.

Given the relatively bigger size, their business had the capacity to survive those three, four, months. They got a tailwind.

Their customers are exporters and local suppliers to these exporters.

Now, with GST, the compliance cost for these suppliers has increased and many have opted for the composition scheme (not paying GST, as the turnover is below the required limit).

Since these exporters cannot avail the benefit if their goods are manufactured by un-organised players (not paying GST), they have shifted focus on in-house manufacturing and organised suppliers.

Even though this has affected sales a bit (as the supply has been impacted), removing these middle men has increased margins for players like them.


If these businesses in my town were listed, the best time to buy them would have been when GST was implemented. It was the time when everything looked like it was in bad shape.

And when a business or industry is in bad shape - valuations are in our favour.

So, for readers of Smart Money Secrets, I have been looking closely at a company which has been facing heat in the last two years. Now the industry has got a flurry of impetus from the government.

The government measures have been stringent, and in the short term have beaten the sector upside down. However, I' m guessing this will lead to good consolidation in the sector.

Even though most of the players in the industry have doubled in the last six months, this company still looks attractive from a valuations perspective. Stay tuned for more...

Editor's Note: As long as you're making smart investment decisions, you should keep your fingers off the bitcoin buy button. Or, is there a way to profit from them too? Find out here.

Will 2018 Bring Any Relief to Struggling Pharma Companies?

While the implementation of GST did cause a disruption among the unorganised players, there was one sector which has underperformed regardless. The BSE healthcare index was the worst performing sector in 2017. In fact, the sector has underperformed over the past three years.

While 2018 earnings of pharma companies are expected to be better considering the low earnings base in 2017, certain challenges still remain.

Valuations of Top Pharma Companies Still High

The valuations of the top five companies by market capitalization on BSE healthcare tell a different story though. Average Price to Earnings Ratio of the top five companies stands at 36. Considering the headwinds these companies are facing, it certainly seems rich.

An improved earnings performance in 2017 will certainly get these valuations to reasonable levels, provided the share price remains the same. But, the headwinds for the sector still exists.

Quicker ANDA approvals has intensified competition amongst generic players. Also, the recent warning letter to Lupin shows the regulatory overhang hasn't been completely resolved yet.

The top generic companies are trying to move toward low competition drugs, which can be seen by their R&D expenditure towards complex generics. This though will take time and substantial expenditure. It might also mean muted earnings in the next couple of years, before the drugs are distributed into the market.

2018 looks likely to be another challenging year for the sector. The uncertainties make it important to be stock specific in the sector.

As of today, three stocks in the pharma sector are currently buy worthy according to The India Letter (subscription required). These are the pharma stocks we believe will outlast the others in the long run.

Cement Sector to Get a Boost in the 2018 Budget?

Like the BSE Healthcare sector, Cement stocks struggled last year. As of March 2017, the capacity utilization was 75% out of a total available capacity of 375 million tonnes. This excess capacity led to intense competition. As a result of this, cement prices were down.

Then the Supreme Court banned the use of petcoke in areas around New Delhi including Rajasthan, Uttar Pradesh, and Haryana. This is a higher pollutant alternative to coal.

Cement producers prefer petcoke over coal because it had a better quality and price. More than 70% of the fuel requirement in the cement sector is met through petcoke.

Coal isn't just expensive, it is difficult to procure in adequate quantities. This shift from petcoke to coal is likely to result in a 15-20% increase in cost.

The cement sector is looking at the 2018 budget in February with a sense of optimism. The Indian Property market has been on a downtrend in India in the past few years affecting cement demand.

Cement players expect a higher allocation from the government towards the infrastructure space. A boost to the Real estate sector would result in higher demand for cement.

With 25% of capacity lying idle, cement producers would be able to meet the need for excess demand comfortably without much capital investment. This will boost their margins going forward.

What the Markets Looked Like This Week

After a positive start to 2018, global stock markets sustained the momentum in the week gone by. Majority of the global indices ended in the positive territory. The US markets were the biggest gainers, rising by 2%, on the back of a stable economy and prospects of a good earnings season. U.S. retail sales rose 0.4% in December, the fourth straight monthly gain. The consumer-price index rose 0.1% in December.

The euro firmed up, hitting a three-year high against the dollar after German lawmakers reached an agreement on a blueprint for a ruling coalition between Chancellor Angela Merkel's Christian Democrats and the opposing Social Democrats. A weaker greenback is expected to boost the profits of the multinational companies in the US.

Also in Europe, the British pound moved to its highest level since the U.K.'s vote to leave the European Union as reports indicated that Netherlands and Spain want to work toward a "soft" Brexit. Barring Germany, equity markets in France and UK ended on a strong footing.

In the Asian markets, barring the Japanese index, all the others ended in the green in the week gone by. The Indian markets continued to remain on a firm wicket with indices scaling fresh highs. Positive trade in global market and expectation of revival in domestic earnings propelled the markets to record levels. This was the sixth weekly gain in a row for the benchmark.

In the commodity markets, oil prices resumed their climb, trading near 3-year highs, as Trump extended temporary waivers on U.S. sanctions against Iran. In cryptocurrencies, the bitcoin spot price rose 2.7% to $13,640.

Back home, realty, IT and oil & gas led the rally for the week. Only, telecom, auto and power stocks ended in the red.

Investment Mantra of the Day

"If you aren't thinking about owning a stock for 10 years, don't even think about owning it for 10 minutes." - Warren Buffett

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