Published on 4/01/2018 5:37:28 PM | Source: Kotak Securities Ltd

Consumer Products - Anti-profiteering - a few thoughts - Kotak Sec

Posted in Broking Firm Views - Sector Report| #Kotak Securities Ltd #Consumer Goods Sector #Sector Report

Anti-profiteering – a few thoughts.

We do not have enough resources or data points at our disposal to comment on whether CPG, retail or QSR companies have engaged in ‘profiteering’ post GST implementation and/or after GST amendments. That there is noise on this aspect begs an important question, though – are individual ‘relevant markets’ (a specific FMCG category, a foodservice vertical, etc.) competitive enough in India? If they were – (1) any category-level benefit would be competed away and (2) there would be no scope of ‘portfolio-level’ benefit-pass-through decisions.

Anti-profiteering – the definition and why we are challenged to test any hypothesis around it

Cambridge dictionary defines profiteering as “the activity of taking unfair advantage of a situation to make a large profit”. Wikipedia suggests that “profiteering is a pejorative term for the act of making a profit by means considered unethical”. defines it as “… taking advantage of unusual or exceptional circumstances to make excessive profits… usually, there is no government control over profiteering unless it involves any illegal means”.

Two quick points here – (1) the dimensions of profiteering range from ethical to legal, and (2) context or situation or circumstance is an important element; for example, a massive jump in profits in a particular phase when an important raw material (say crude oil) falls sharply is perhaps not a case of profiteering; RM down-cycle is not an exceptional circumstance. However, an event like GST implementation does classify as a ‘specific situation’ or an ‘exceptional circumstance’, in our view.

That there is a strong legal element to the test of profiteering is why we (and the Street, in general) are challenged to comment with any level of depth on this issue. Taking a view on a subject that involves legality needs resources and more importantly granular details of various value chains that we do not have any access to.

Our purist view is that (1) GST implementation is an ‘exceptional circumstance’, (2) businesses collect indirect taxes from the consumers on behalf of the exchequer, (3) while some pricing flexibility around changes in indirect tax structure/rates in ‘normal circumstances’ is perhaps fine, there should be a simple and straight 100% ‘pass-through’ of GST-induced change in ‘net indirect tax incidence, taking into account changes in input tax credit availability’ for all products or services, especially in cases where the net tax incidence is reducing and (4) by extension, there should be no ‘portfolio-level’ flexibility on benefit-pass-through decisions.

The more important question – is the Indian FMCG/QSR/retail sector competitive enough?

Your scribe has covered the Indian wireless sector for the past many years and knows a thing or two about what competitive industries look like. The wireless sector, already stressed, just absorbed a bulk of the GST-induced sharp increase in net indirect tax incidence. We are not too sure if the Indian FMCG (including QSR and to some extent, even horizontal and vertical retail) industry is competitive enough. A simple test of competitiveness to us is what an industry does when there is a common material benefit accruing to all players – does the benefit get passed on to the consumers? If yes, is it passed on wholly or only partly? The recent (sustainable, per management commentaries) sharp jump in profitability of most companies in our coverage universe through the crude-led RM down-cycle suggests less-than-perfect (fairly benign, in our view) competition to us. So does the sharp fall in overheads and associated jump in margins in 2QFY18 (the first quarter post GST). As we said, we do not have enough details to say whether this was on account of partly/fully retained ‘higher input tax credits’ or not.

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