Corporate tax cuts announced - Citi analysts raise Mar’20 Sensex target to 40,500 (39,000 earlier)

23 SEPTEMBER 2019

Citi analysts raise their Sensex target multiple to 18x from 17x earlier. Sensex has rallied by ~8% in the last two trading days, on the back of these developments.

  • Broad based reduction in corporate tax rates gives a definitive boost to corporate EPS.
  • There is a likely medium/long term boost to domestic manufacturing.
  • For 145 Citi research covered companies which include most of the top 200 listed companies, the aggregate effective tax rate (ETR) for FY19 was reported to be ~30% (excluding the loss making companies).
  • The corresponding ETR for Sensex/NIFTY companies was ~31%.
  • Citi analysts estimate that the tax rate changes announced may result in ~6% reduction in the ETR to ~24% in FY20. This may imply an 8-9% increase in earnings for the coverage universe (holding all else constant).

The actual earnings impact may vary depending on whether:

a) Companies pass on some benefits to channel partners or end consumers to boost top-line growth.

b) Companies choose to stick to the extant rate if their cash tax rate is lower than 25% due to certain incentives or exemptions.

Further, it was announced that the tax rate for new manufacturing companies established between Oct’19-Mar’23 will attract a lower tax rate of 15% (17% including cesses & surcharges).

  • Citi analysts believe this may potentially be a boost to capex cycle and Make in India.
  • It may accelerate corporate capex decisions.
  • India may become a significantly more attractive destination for global manufacturing looking to shift away from China.

These measures may have significant medium to long-term growth prospects. Further, these measures also addresses some of the investor concerns on the reform momentum from the government.

Source: Study by Aswath Damodaran, NYU-Stern, Citi Research

In our previous note Markets More Reasonably Priced, with Limited Downside, we did highlight that the relative attractiveness of equity Vs. bonds had improved post correction, as the Earnings Yield Gap (10yr bond yields - Earnings/Price) had narrowed. We also highlighted that Equity investments have returned 16-17% in the past couple of instances after the gap was at similar levels.

Investors may continue to stick to their strategic asset allocation as per their risk profiles and ensure diversification in investment portfolios. For more details and implications for your portfolio, please contact your relationship manager.

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