Objective of the Article: Objective of the article is to share thoughts on Equity Markets for Small, Medium and long term investors covering their personal portfolios. Well Pls be note that below said is author independent view however markets would change accordingly due to variety of Global and Domestic factors where author is having no control. Please have your own independent view before investing in Equity Markets.
Not many top down catalysts:-
The union budget 2016 contains few top down market catalysts. Keeping the FY17deficit target at 3.5% creates room for rate cuts, which can help. The budgeted increase in revenue expenses does not seem to fully factor in Pay commission costs (or means other spends will grow slower difficult to isolate). Disinvestment / telecom / dividend revenue targets are steep while that on oil excise is below current rates. Tax changes were not as bad as feared (no capital gains, modest service tax increase).
The 10% tax on dividends received above Rs.1mn appears to have spooked the market, but this does not apply to companies (would have hurt other income otherwise). Modest STT on options higher taxes for high earners and cuts in tax incentives round up major tax proposals. Allocations focused on roads / irrigation / social issues (healthcare, insurance) as expected. The budget in itself should have limited impact on market which should revert to focusing on earnings trends and global cues near term.
Key sector / stock changes:-
• The weighted 10% increase in excise on cigarettes is in line with expectations ITC(Buy) will be required to raise prices <10% in cigs to achieve our FY17 growth.
• Removal of DDT positive for REIT structuring. Prestige (Buy), DLF (U/P) can gain. Measures to support affordable housing good for Sobha (Buy), HDIL (U/P).
• Lack of crude customs duty positive for IOC/BPCL/HPCL (Buys). Coupled with lower than expected reduction in oil cess hurt ONGC (Neutral) and OINL (Buy). Increase in gas prices for deep water (if for existing discoveries) can help RIL (Buy), ONGC.
• Bank recap allocation of Rs.250bn was lower than expected hurting PSU. Focus on affordable housing helps HFC Measures to help asset reconstruction companies good for long term resolution.
• Reduction of R&D incentives (from FY18, and FY21) will hurt pharma companies(DDRD CDH by about 5% each in FY18 about 4% for sector on average).
• Introduction of tax deducted at source of 1% on the sale of cars with value in excess of Rs.1mn and any cash transaction of more than Rs0.2mn infra cess of 1% on small petrol, LPG, CNG cars and 2.5% on diesel cars of certain capacity and 4% on other higher engine capacity vehicles.
• Increase in Clean Environment cess on coal (from Rs.200 to 400/ton) will largely be a pass-through for power companies but can hurt cement companies.
• The 0.5% increase in service tax is marginally negative for BHARTI /IDEA (Neutrals)and DITV (Neutral). High Telco revenue targets imply hopes of 700 MHz auction.
Overall Budget Impact: Negative for the sector
Negative for: Dr Reddy, Glenmark, Sun Pharma, Lupin, Aurobindo
Key measures / Impact of measures
• Deduction for expenditure on scientific research (R&D) from 200% to 150% from April ’17 and eventually phasing it out from 2020. This will have a negative impact on most of the Indian pharma companies
• A special patent regime with 10% tax rate on income from worldwide exploitation of patents developed and registered in India: Positive for the Pharma companies such as Sun Pharma, Dr Reddy’s, Lupin and Glenmark
• Duty drawback schemes to be widened: Positive for export-oriented companies such as Aurobindo, Lupin, Dr Reddy’s, etc
• The government will open 3,000 stores to reinvigorate the supply of generic drugs: Negative for pharma companies however, successful implementation of the same is a key
• Health cover up to Rs 1 lakh per family for BPL (Below Poverty Line) families: Positive for health insurance firms and drug manufacturers
• Earnings sensitivity because of deduction for expenditure on R&D: While working on the impact/sensitivity on the pharma sector from deduction for expenditure on R&D, we have to consider the following facts:
• Firms paying MAT or below MAT (Minimum Alternative Tax) may see a limited impact given their overall tax structure such as SUNP and Cadila Healthcare.
• Weighted R&D deduction was only applicable to R&D spends incurred within India and centers approved by DSIR (Department of Scientific and Industrial Research).
• While calculating the impact on FY18 earnings, we have considered the full corporate tax rate. However, if the government brings down the corporate tax rate by FY18, then corresponding impact will be negated to some extent
Overall Budget Impact: Positive
Positive for: REITs (DLF & Prestige) and Affordable Housing (Sobha & HDIL)
Negative for: None
Key Measures/ impact of measures
• No Dividend Distribution Tax (DDT) for REITs: Positive for developers who hold large rental annuity portfolio. DLF with annual rental roll of Rs24bn and Prestige with annual rental roll of Rs5bn would be the key beneficiary. REITs can potentially help deleverage stretched balance sheets.
• 100% deduction on profits of developers building affordable housing project for flats up to 30sqm in four metro cities and 60sqm in other cities, approved during June 2016 to March 2019, and is completed within three years of approval.MAT of 18.5% would apply- This is positive for affordable housing projects. Sobha and HDIL would be key beneficiary as affordable housing with units priced under60sqm forma notable portion of their ongoing housing project portfolio
• Increase in HRA deduction for households paying rent from Rs24, 000 toRs60, 000 per annum: No impact on developers. Positive for overall sector sentiments
• Additional Rs50, 000 deduction on mortgage interest amount for first-time buyers on home loans up to Rs35 lakhs (home value up to Rs50 lakhs) - Positive for affordable housing and overall sector sentiments
• Service tax exemption for housing up to 60 sqm: Positive for developers building affordable housing. HDIL would be key beneficiary. A significant portion of HDIL’saffordable housing portfolio in out-skirts of Mumbai city are sized under 60sqm.Prestige and DLF have the most levered balance sheet. Given their annuity portfolio, they can de-lever their balance sheets using REITs
Overall Budget Impact: Neutral
Positive for: OMCs
Negative for: ONGC, OIL
Key Measures/ impact of measures
• Cess on domestically produced crude oil changed from Rs4, 500/t to 20% advalorem: A major disappointment against expected ad valorem cess rate of 8-10%.Although at current oil price of $35/bbl oil, the incidence of cess reduces from c. $9/bbl to $7/bbl, but ONGC/OIL will have to pay higher cess when oil price exceeds $45/bbl. On our $51/bbl oil price forecast for FY17, we estimate EPS downside of 6-7% for ONGC and OIL.
• Adequate subsidy provision of Rs269.5bn for FY17: Petroleum subsidy is projected at Rs269.5bn vs Rs 300bn in FY16. At our oil forecast of $51/bbl in FY17,we project overall under-recoveries of Rs334bn, with government share of Rs311bn, based on FY16 subsidy sharing formula (Government share restricted toRs12/liter for kerosene and Rs18/kg for LPG). The projected subsidy implies an oil price assumption of c. $48/bbl, implying some buffer for higher oil price.
• The assumption of higher oil price is also likely reflected in the conservative estimates of excise collections, which projects yoy growth of Rs220bn in FY17versus our estimate of Rs660bn. We highlight that even last year, the government had budgeted a lower amount and ultimately collected over Rs430bn more than estimated (excluding incremental Rs180bn from five excise hikes in FY16). The headroom mitigates risks to OMCs earnings with government likely to cut excise incase of sharp oil price increase.
• Pricing freedom for difficult gas: To spur domestic exploration, government has proposed calibrated pricing freedom for “new discoveries and areas which are yet to commence production” in deep sea, ultra deepwater and HPHT (high-pressure, high-temperature) fields, with a pre-determined ceiling price based on landed cost of alternative fuels. This is a long overdue step, first proposed in Oct’14 when the new pricing formula for domestic gas was announced. However, there continues to be a lack of clarity both on the structure of pricing freedom as well as whether thesame is applicable on already discovered fields. In theory, each $0.5/mmbtu
• Increase in gas price lifts ONGC/OIL’s FY17 earnings by 7%/4%, respectively. However, given the typical time period of minimum 4-5 years from discovery to production, we expect little earnings boost. However, if the pricing premium is available on already discovered fields, clarity on higher gas price realizations could facilitate the development of several discoveries with RIL and ONGC, which could help medium term valuations.
• Universal coverage of cooking gas: Allocation of Rs20bn to extend LPG connection to cover 15m poor households in first year. The scheme will continue for at least next 2 years to cover 50m households ensuring universal coverage of cooking gas. As of Oct, total number of active LPG consumers was pegged at148.5m, implying a 33% increase in connections over the next three years. Christened as ‘Ujjawala’, the scheme provides a financial support of Rs1, 600 for each LPG connection to the BPL (below the poverty line) households (vs average price of Rs3, 400/cylinder).
• Withdrawal of 80IB benefits for oil and natural gas if the production commences on or after 1st Apr 2017: Section 80IB provides for tax holiday for seven years. Government estimated the revenues loss of Rs67.4bn for FY15 last year on account of this exemption. A modest negative for the upstream sector and inconsistent with the objective to increase domestic self-sufficiency. However, we note that the applicability of minimum alternate tax had reduced the attractiveness of this benefit.
Disclaimer: -Author is having his own independent view on Equity Markets and requesting all Equity Traders to have their own Independent view as well before investing. Author suggesting to have long exposures on Banking, OIL and Technological Companies however keep strict stop loss. Traders are advised to have a look at Impact of volatility levels in their Portfolios.
Good Luck Traders!!
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