September 20th – Massive Corporate Tax cut and it’s impact on equity Markets

Amid growing concerns over the economic slowdown, the union finance minister, Nirmala Sitharaman announced a slew of incentives aimed at stimulating a flagging economy whist maintaining emphasis on domestic manufacturing and demand. One of the most important announcement was lowering of Corporate tax rate from ~35% (including surcharge) to 25.17% a massive reduction of almost 10%.

This move will help companies to increase profitability. One hopes some of these benefits are passed on to consumers and that some are reinvested for business expansion.

This is a permanent benefit for corporates. Even-lower tax rate (of 15% – almost the lowest tax rate globally) for new manufacturing companies will make Indian manufacturing significantly competitive. This will hugely boost the government’s ‘Make in India’ campaign. This move is expected to provide a meaningful boost to exports, which earlier looked difficult due to our lack of competitiveness.

Equity Markets cheered this move as it provided boost to EPS growth.

Average effective Corporate Tax rate Across sectors:

Source: Phillips Capital

As seen from the below graph, Average effective tax rate have come down from 30-34% to 25%

What this means to EPS growth.

We will do an illustration to understand the impact.

Consider a company having EPS of Rs.1,000, primary assumption is that the company EPS will grow at 12% for year 1-5 and then will grow at 5% for Year 6-10, the terminal growth (Perpetual) is assumed 3%. Discount rate is assumed 12%. Now if we do a Discounted Cash Flow (DCF) analysis, then the total PV of Cash Flows which we get is Rs. 17,425.

As the tax rate is cut by ~10%, earlier if my profit was Rs.100 I was charged Rs.35 as tax and I used to receive Rs. 65 in my hand net of tax. With tax rate now coming down to ~25% I will get Rs.75 in hand net of Tax. So, roughly I will have 15% more in hand net of Tax.

Now if I consider same company as above, my EPS goes up by 15%, so EPS increases to Rs.1,150. With all other growth assumptions remaining same, Total PV of cash Flows which we get is Rs. 20,039 or 15% higher than the original estimate.

But, other important point to consider is the discount rate.

Yesterday, the Benchmark 10-year bond yield went up by 15bps. So, if we consider the discount rate as 12.15% instead of 12%, the EPS growth comes down to ~12.75%.  

Yesterdays announcement is expected to have total revenue loss for the government from the corporate taxes foregone would amount to Rs.1.45 lakh crs. Additionally, the export promotion measures announced on 16-Sep’19 would lead to an additional revenue loss of Rs.10,000 crs over the budgeted revenues for 2019-20. The loss in revenue could to an extent be made up from the RBI surplus transfers (Rs.58,000 crs over the budgeted amount). Also, GST collection and Direct tax collection is also not upto the mark. The overall impact could be widening fiscal deficit which can lead to higher yields.

If the yields increase by 1.25% then with discount rate touching 13.25% instead of current assumption of 12% will make this tax cut worthless i.e. Total PV of cash flows will be Rs. 17, 412.

Hence, one needs to keep an eye on Fiscal position as well.

Taking Care Of Your Money – The 3 Excuses

Never Taught In School

Understand some simple principles and practicing them will help us take charge of our financial fitness. It is helpful to spend an hour or two with a financial planner to understand these.
However, most people are hesitant to do this, and there are typically three excuses:

The 3 Excuses

1. My parents did fine without planning

All this idea of financial planning is okay. But, my parents did so well financially. They never needed any plan like this!

Things have changed. Life different for the earlier generations. The conveniences and luxuries did not exist – which today make demands on our money. We have shifted from joint family to nuclear family. While we will do everything to give the best future to our children, do we wish to depend on them for looking after us in our old age?
We want to become financially independent to live with a sense of self worth and self respect. That’s why, we need planning!

2. Where is the money to save and invest?

“I earn well, and so does my spouse. But we need to keep up our lifestyle. Everything’s getting so expensive”

It is not easy to save money. Just consider – We must give something to ourselves first! We are the two most important people in my life! Look at the equation below.

Income – Expenses = Savings

For financial success, change it to:

Income – Savings = Expenses

3. I am comfortable now, and this is how it is going to remain

But I am leading a comfortable life now. Retirement is far away. I will certainly save for retirement, not now, but later – when my income is higher

Sounds logical, right? But have we taken inflation into account? Do we want to go through life’s journey without a map? Can I have the freedom to retire early?

To take of these, meet a financial planner. Create your roadmap and,

  • Start Early
  • Save consistently
  • Invest wisely