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What Could Impact Fiscal 2017 Earnings More than GST?

Dec 11, 2015

In this issue:
» India's job engine running low
» Ongoing controversy on Maruti's Gujarat plant
» Strong year for IPO market
» ....and more!
00.00
Tanushree Banerjee, Co-Head of Research

GST is an acronym that hardly any news media, blog or expert, has failed to mention in the past few months. This acronym, once law, will massively impact corporate earnings.

I hate three-letter acronyms. They make the ignorant reader feel like a fool. Moreover, one has a tendency to read them positively without knowing the meaning, let alone the full form.

Probably that is what happened between 2005 and 2008 on Wall Street. Investors were in awe of the firms' ability to churn out complex derivative instruments, referred to by their three-letter acronyms.

These never-heard-of investment products attracted investors by the hordes, aided by the promised unthinkable returns. Investors never realised that their bankers were packaging and repackaging an asset worth US$10 to sell them at US$100.

It was only by mid-2008 that few came to know the full form of the fancy investment they held. CDS in full form is Collateralised Debt Securities. In simple English, this means that the mortgage on houses was packaged and repackaged from one bank to the other and finally sold to investors as attractive investment products. But the mortgages were actually subprime loans with the borrowers more likely to default than service the loan.

By the time the subprime bubble burst, not just small investors but even big banks such as Lehman Brothers and Goldman Sachs were at brink of bankruptcy. The fancy CDS turned out to be the nail in the coffin of Lehman as well as thousands of retail investors.

The Indian economy avoided such a crisis. The RBI has done a brilliant job of keeping banks' risk appetite in check. Subprime loans such as the teaser home loans were rejected before they became dangerous. Even if a bank ever came to the brink of solvency, its depositors' interest was always safeguarded.

However, yet another three-letter acronym has the potential to malign the RBI's reputation and halt all the good that GST would bring to India's GDP. Possibly by March 2017, investors will be dreading its impact on corporate earnings rather than counting any GST goodies.

SDR, or Strategic Debt Restructuring, was a scheme meant to help banks swap unpaid debt for majority control in a company. But banks in India have used it to their advantage to camouflage unrecoverable debt.

The first SDR was offered to Electrosteel Steels to tackle Rs 106 billion of debt, more than 11 times its market capitalization! Since then, such ridiculous SDRs have been the norm. All SDR accounts put together amount to Rs 641 billion of loans. This is a little more than 1% of total loans in the banking sector and close to 1% of India's GDP.

The RBI has set a deadline of March 2017 for banks to acknowledge such bad loans and provide for losses. This means several companies will lose their controlling stake to their bankers, and the banks will have to take a big cut in profits.

So one could look forward to GST, anticipating India's GDP growth to go up by a percentage or two. By 2017, GST could certainly boost corporate earnings. But, for all we know, it could be SDR rather than GST impacting 2017 earnings more than we can imagine.

Do you think factors other than GST could have a big impact on corporate earnings over the next two years? Let us know your comments or share your views in the Equitymaster Club.


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2.20 Chart of the day

2015 has been a disappointing year for stock markets. But one cannot really complain about stocks getting listed through IPOs as these have witnessed quite a positive response. Companies have raised around Rs 130 bn during 2015, highest in last five years. Among the various IPOs, there were three major IPOs in the healthcare segment, which particularly received strong response.

Now, healthcare is a sector which we believe could be one of the key beneficiaries of the Golden Decade Megatrend so we are taking keen interest in analyzing these IPOs (requires subscription). However, investors should bear in mind that not all companies will create value and therefore their decision to invest should be based on fundamentals and valuations.

Select Oversubscribed IPOs of 2015

3.00

Minority share holder activism is becoming quite conspicuous in the Indian domestic market. Some companies like Tata Motors, Maruti Suzuki, S Kumars are some examples that have experienced the force of investor displeasure. Among these, the controversy surrounding Maruti Suzuki's Gujarat plant has been an eye catching episode which started early in 2014.

In this case, the institutional investors are opposing, the proposed takeover arrangement made for the Gujarat plant. According to the arrangement, Suzuki will form a 100% subsidiary in India solely with the aim of setting up the Gujarat manufacturing plant. This means that the funds required to set up the plant will be bought in by Suzuki into the subsidiary. Maruti Suzuki will source cars from this subsidiary to be sold not only in the Indian market but also for exports. This arrangement is made despite Maruti having sufficient cash to set up the plant. The company's rationale at the time was that it did not want to spend the cash on capex but utilize it for marketing and expanding its distribution reach. What also irked investors at the time was that the company announced this move without shareholder approval. Since then, the company has made changes to the arrangement and the proposal is now being put up for vote for minority shareholders.

Radhika Pandit, Managing Editor of ValuePro had written about this in one of our editions of the 5 Minute WrapUp Premium (Subscription required). This is what she wrote -

"Prima facie, though unusual, the arrangement for the time being does not appear to be against the interest of minority shareholders. Having said that, the key thing to watch out for will be whether Maruti Suzuki ensures that the 100% subsidiary is for the objectives stated and that Suzuki does not divert profits, that would otherwise accrue to Maruti, to the unlisted subsidiary. Thus, it would be prudent for investors to factor in this point when it comes to valuing the stock"

4.15

Job creating opportunities have a direct relationship with state of the economy. During economic slowdown the job market typically languishes. As reported in Mint, the job creation activity in manufacturing and export-oriented sectors has plunged to six year low levels. The prime reason for this plunge is largely attributable to the country's falling exports. Reportedly, India's merchandise exports contracted for the eleventh consecutive month in October. The weak external demand has been an important factor for this sluggishness. The last time when exports registered a positive growth was November 2014, the exports increased by 7.27%.

During April-June 2015, of the 43,000 net declines in jobs, export-oriented companies reported a decline of 26,000 and the rest was in non-export oriented companies. The textile sector jobs declined by 17,000 and that in automobile industry by 18,000. Similarly, other sectors like IT/BPO, handloom, gems and jewellery and transport too plunged during this period.

Lack of job creating opportunities was one of the biggest challenges during UPA's regime. While the new government has been taking steps to reignite the investment cycle and create job opportunities, the existing data does not represent a healthy trend. Hence, it would be interesting to see whether stimulus to manufacturing through Make in India and GST help resolve the issue.

4.45

After opening on a flattish note, the Indian markets have witnessed selling pressures and are trading well below the dotted line. At the time of writing, BSE Sensex was trading lower by about 200 points. All the sectoral indices were trading in deep red with stocks from realty and banking sectors facing maximum brunt. The midcap and smallcap indices were also trading quite weak.

4.50 Today's Investing mantra

"What we learn from history is that people don't learn from history." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee (Research Analyst) and Bhavita Nagrani (Research Analyst).

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