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“If the fundamental theory is that demand is not going to get adversely impacted because of GST, then the earnings impact is not going to be permanent one”, said Upadhyaya.

In an interview to ET Now, guests Ajay Srivastava , CEO, Dimensions Consulting andHarsha Upadhyaya , CIO-Equity of Kotak AMCspeak about some of the major probable outcomes of the soon to be rolled GST and the sectors to be benefited most by the new tax method. Edited Excerpts:

Now we all know most companies across the consumption space operate in the informal economy, how smooth do you think the shift to the formal sector would turn out to be?

Harsha Upadhyaya : It is a significant reform that has been happening since the last two or three decades in our country. So to that extent I think there could be some implementation issues but beyond that if you see I think there is going to be a clear shift from unorganised segments of many of the sectors and these will move into organised, listed, branded players. So the incremental market share gains are going to be gradually in favour of organised players. Let us look at some of the consumer centric businesses most of them have large unorganised or pools of business today for example paints if you take it may be 30-35% of the industry is still very unorganised.

On the higher side if you look at industries such as jewellery, electrical appliances may be air coolers maybe 70-75% of the industry is unorganised at this point of time. So this is the pool which is available for branded listed players to actually go and get and this is not going to happen overnight so may be over a period of few quarters, few years there is going to be a gradual shift towards organised players and that is what the listed space offers. Hence, we believe some of the sub segments that I have mentioned can offer a better growth rates for listed players and we can look at some of the investments in that particular segment.

One of the key outcomes of GST will be the big shift from unorganised to organised model of doing business how do you think this scenario is going to pan out?

Ajay Srivastava : See if it had come on a standalone event of the GST, in a background of a good economy, the transition would have been much easier and that transition is not about short the smaller companies shutting down and the larger companies getting market share. It is also about consolidation plays etc. I think what is emanating is in the background of the demonetisation impact that these small and unorganised sector was quite weak in any case. So now we are looking at a new scenario that if they cannot adjust to this, cannot adjust the cost, cannot manage the cash flows required in the GST module then you are looking at an extension of a large part of economic activity and I am being little bit perhaps alarmist to say that a large segment of the economic activity could become if not paralysed could have a severe adverse impact for a very long period of time without getting the benefit of consolidation. So quite obviously it will have a very great negative impact on the unorganised sector, the cost will change, meeting the administrative cost will change, and to the extent that we may not like it that the cost disadvantage or advantage vis-à-vis bigger players that is going to disappear. So all in all we are looking at it is not going to just the unorganised sector, the broadly the economy will also suffer.

So what kind of benefits are we really looking at for these smaller unorganised players post this transition to the organised structure?

Ajay Srivastava : I doubt the thesis let us take the thesis forward to say will that be a beneficiary but I guess it is not and the reason is as follows; one is this is the much more intensive process to administer the sales and purchases. Number two is lot of the purchases by the sector was anyway out of the ambit of input credit, so the fact that they can get input credit on a service tax, a telephone bill or whatever it is it is going to be very miniscule. The third thing is the negative is that the cash flows get in any model of our selling today the VAT was paid when the goods get sold to the customer, money was realised, VAT was paid including today’s stock transfers.

Today the module will become that the day the goods ship out you got to pay the GST now the cash flows will be strained, now you know SSIs and etc. the biggest problem is cash flows so I am not with the thesis that it is going to be any beneficial to the smaller sector or the medium sector irrespective of the fact that there is a big benefit of input credit. These people are not the biggest recipients of input credit into most products so they are not going to use it very well at this point of time so the extra levy that the so called on the GST is going to sit on top of their costing so maybe I am wrong but I think my thesis is that small and medium enterprises are definitely not going to get the benefit of this as compared to the larger companies.

We are looking at a large unorganised informal market- 65% of footwear industry, 35% of paints, biscuit industry is all unorganised. Air coolers have a big informal market and then of course while the listed pool maybe very large for auto ancillaries. How exactly is the listed players likely to benefit once this shift happens?

Harsha Upadhyaya : For argument sake let us look at some product which was getting taxed at the hand of organised player but not at the hands of the small scale industry. Let us say the product costs Rs 100. Now under GST, it would cost 118 for an organised player whereas which as Rs 80 let us say for example for an unorganised player probably he was not under the tax net and hence the price arbitrage was very-very large. So at that level even if there a quality which is inferior, they were able to sell that product. But today assuming that they are at 80 they will also have to pay GST.

So the difference between the two products is not going to be very huge. So to that extent, people will prefer better quality products and hence the tax arbitrage which was giving them pricing power for the let us say unorganised sector is unlikely to remain going forward or at least it is going to minimise. So to that extent, it is going to be better playing field for organised players and hence we believe with their brand equity, with their quality they will be able to gain incremental market share from unorganised players in many cases. So the burden of tax compliance will increase on smaller players. They have not been used to do this so there could be more implementation hiccups at their end compared to some of the larger players. So that will again aid incremental market share gains for organised players.

In this unorganised to organised play, what are the sectors that are most likely to benefit?

Ajay Srivastava : I think the one bigger sector would be apparels. Apparels is the largest industry which is in the unorganised sector today that will move heavily towards the larger corporates because you saw the whole from the handloom sector downwards to the power loom to the manufactures of yarn to the textile weaving companies all of them getting impacted on the adverse side. Who are the gainers? The large companies with brands will be the big gainers because they will have the power and muscle to move into this market when the smaller guys are out of it. So apparels to me is the first big segment which will see this move coming through.

The second move is going to be related to building materials and you have your normal taps, your pipes and all those things that you get for house construction that is the second big segment which is very large is going to get quite a bit will migrate to the much larger organised companies, so apparels on one side, building materials and all which goes into house building on the other side and the third I think category would be your utensils and appliances, I think that is a very big category where there were large number of unorganised players. I think there will be huge shake out in that segment. The GST is not a bad news, it is a good thing but these are the fallout, collateral damage which will come through.

What to your mind is going to likely benefit most out of this transition which is going to be indeed a very disruptive change, there will be an earnings impact as well although only transitionary in nature?

Harsha Upadhyaya : We think the impact is going to be transitory in nature simply because unlike demonetisation we do not see that there is going to be destruction of demand because of GST per se. In case of demonetisation, at least some segments saw clear destruction of demand for a temporary period as well as from longer term basis even the luxury consumption took a beating but in case of GST whatever impact adverse impact on the demand that we are likely to see it is going to be only during the transition period. It is unlikely to continue. So if the fundamental theory is that demand is not going to get adversely impacted because of GST, then the earnings impact is not going to be permanent one.

So there could be some of the things that we have already seen in some channels for example some of the sectors are seeing discounts being offered, some of the sectors are seeing some kind of rundown of inventory destocking so those things could impact June quarter earnings for few of the players but I think as you enter September most of this should get normalised if there has been a destocking in a particular sub-segment, that stock will get restocked starting July. So between June and September quarters, I think most of the earnings impact that is going to be there just because of GST implementation should get normalised. And over a period of time as we discussed earlier, it is going to be really a positive impact for organised players.

So from a medium to long term perspective I think it is going to give a better earnings growth trajectory for listed players but in the short term there could be ups and downs but between June and September quarters even that should get normalised.

So, how apparels, being the most disorganised sector, is likely to benefit most post the GST implementation; what is that one listed sector that you are betting big on where you think it is going to be the maximum benefit be derived once the shift from unorganised to organised happens?

Harsha Upadhyaya : We are not betting on one single sector as such, there are opportunities across many industry sub segments most of them are consumer centric. It could be in consumer staples, it could be in consumer durables or it could be in the area of home improvement so most of these sub segments have large unorganised pools for example within FMCG if you look at paints or may be 30-35% of the market is unorganised today. Biscuits it could be a similar number but if you go to something like footwear may be it is about 65%. In case of consumer durables or discretionary consumption, if you look at something like electrical appliances or A coolers may be it is about 70-75%.

In case of jewellery it is about 75%, in case of home improvement if you look at segments such as tiles may be it is about 50% of overall market is unorganised market so as you see there are large pools of unorganised players who are still operating here and most of them would lose their pricing power and hence I think that kind of a market share will be up for grabs and listed players will gain. So we are looking at a cost section of lot of these companies and trying to build a portfolio out of it.


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