‘Rally can reverse course if not supported by positive corporate commentary post Dec quarter’

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Liquidity-driven rallies can reverse quickly if not backed by positive corporate commentary. Festive season demand of November-December 2019 holds the key here, Rajesh Cheruvu, Chief Investment Officer, Validus Wealth, said in an exclusive interview to Moneycontrol’s Kshitij Anand.

edited excerpts:

Q: What are your views on the government’s decision to slash corporate tax rate? Some are even saying this is the biggest reform since 1991.

A: Definitely, this has been a great structural reform by which government has targeted multiple focus areas: boost to Make in India manufacturing programme, improve export competitiveness, make India an attractive destination for foreign investors, equalise tax treatment of all domestic sectors, reduce tax arbitrage for unorganised sector, etc. This should attract investments from foreign and domestic investors. But India is currently going through two downturns 1) structural slowdown due to aggressive structural reforms like demonetisation, GST, RERA & IBC, and 2) cyclical slowdown due to global trade war, domestic liquidity crunch-led consumption disruption. All the announcements from the FM so far have addressed the structural/supply side constraints but none to revive the demand.

The Union government has clearly played the role of “Big Brother” taking a leaf from Trump’s taxation plans and also playing a role model for state governments. Taking a hit on its source of revenues could inspire the states to follow suit, flexing their budgets and push consumption demand at granular levels.

Q: Can we say that the government has given a Diwali gift to corporates in advance and reversed the bearish trend in the market?

A: Surely an early Diwali bonus, as the new tax regime is applicable with immediate effect and for FY2019-20 itself, if the corporates so choose. This reform has reversed the bearish trend in the markets and it can be seen from restart of FPI inflows. But, revival of real sentiments (consumer or business confidence) cannot be confirmed just by looking at the stock markets’ reaction. Real sentiments revival will depend on the manner in which the stimulus is put to use by companies-direct benefits transfer to consumers, capex for expansion, debt repayments, dividends or just increasing reserves.

Q: If the momentum continues, can we hit a fresh record high by Budget 2020?

A: Given the two-day reaction post announcement, it is quite likely that liquidity flows (from return of FIIs and DIIs record-high cash deployment) will push the markets to record high even before Budget 2020 (need a 4.4 percent upmove to cross last high of 12,103 on Nifty as of September 24’s close). Valuations though are better than before on forward basis due to direct below-the-line earnings, upgrades they continue to be expensive on long-term averages basis. Hence, liquidity driven rallies can reverse course quickly if not supported by positive corporate commentary post December quarter. Festive season demand of November-December 2019 holds the key here.

Q: What is your reading of the buyback tax on listed companies? Will it lead to more buyback offers?

A: The buyback tax has not been rolled back completely as was demanded by the industry. The exemption from buyback tax has been given to only those listed companies who announced their buyback plans before the budget of July 5, 2019 and it is not prospective. Given the high gross-up tax rate of >20% on income distribution (both buybacks and dividends), the government in a way wants companies to deploy the savings towards productive capex or price cuts to boost demand.

Dividends are further taxed in the hands of shareholders at 10%, if the dividend received amount is greater than Rs 10 lakh in one financial year. Buybacks are currently not taxed in the hands of shareholders, but there are some regulatory issues that need more clarification from the government concerning taxation with regards to type of buyback (tender offer or direct stock exchange platform).

Q: Which companies or stocks are likely to benefit the most from the corporate tax cut?

A: Primarily, companies which are currently having a high effective tax rate of greater than 25.2 percent (which is the new ETR) should benefit.

On top of that, companies with a higher ROE will benefit more, as increased profits from tax savings will grow at a higher rate in high return on equity (ROE) companies than in low ROE companies.

Companies with low dividend payout ratios (inversely, high retention ratios) will also see faster value accretion.

Companies with a combination of all of these factors will see their stock prices galloping the fastest.

Other factor to be considered is around deferred tax assets and liabilities. Reduction in corporate tax rate will result in restatement of DTL/DTA in the balance sheet with corresponding write back/off in the P&L. While companies carrying DTL will benefit from write back of deferred tax liability, the impact will be negative for companies carrying DTA.

Sectors likely to benefit: banking (more so private banks versus PSU banks), financials (NBFCs but not so much HFCs), auto and auto ancillaries, FMCG, staples, cement, metals, materials, oil & gas, utilities.

Sectors not likely to benefit much: IT, Pharma and a few FMCG companies.

Q: What are your views on the government which has been proactive in boosting the economy and putting India back on the $5-trillion economy mark?

A: The government has certainly heard the pleas emanating from the dismal 5 percent YoY quarterly GDP print of June 2019. The slew of reforms, ranging from PSU bank mergers, their recapitalisations, real estate reforms, boosting export competitiveness of domestic firms and this latest fiscal push in the form of tax cuts, will no doubt be a pure-hearted case of long-term gain. However, in the interim, some short- term pain might evolve as markets and firms now re-align to the changed dynamics.

Q: Do you think FII flows will reverse following the announcements?

A: FII flows have a long-standing inherent nature that they are sticky. However, any flow reversal if at all does happen, should occur from companies which do not have operating leverage to capitalise on the additional free cash made available to them by the government. Having said that, the reversal of the FPI surcharge announced by the FM on August 30, 2019 along with several other “Make-in-India”-pro initiatives and the basic high growth nature of the Indian economy vs global peers makes India an attractive sweet spot for foreign monies to be parked into. On the debt side, yields could show some hardening in the immediate short term due to uncertainty on borrowing plans, so till then, it remains to be seen how FIIs react.

Q: What should investors do if they have missed the recent rally?

A: Markets will always provide opportunities for a re-entry. Certain stocks will show timing opportunity as the question still remains how demand revival will be brought about by the corporates. Consequently, IT stocks for instance were the laggards immediately after the corporate tax cuts were announced, which offered attractive entry price points. Bottom-up stock selection remains the key coupled with conscious awareness about valuations.

Q: Data suggests that bears control October as the Sensex has closed in the red in six of the last 11 years. What are the big events to watch out for, and how do you see markets moving in October?

A: Major big events to look out for globally would be any global central bank monetary announcements, especially the ECB’s path of providing stimulus and Trump’s tariff movements against other nations.

Domestically, the monthly GST meetings are central to the tune of market sentiment and the hopefully supportive noises made by India’s own RBI. The panning out of festive sales in the form of monthly auto volumes would be another focal point for the markets.

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