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A wholly owned subsidiary; likely for new capex (and for locking in 15% income tax rate)
As expected, HUL has formed a 100% subsidiary to set up new manufacturing unit (s) and to potentially avail lower income tax rate of 15%, in our opinion. As proposed by the government in FY20, new investments in manufacturing and commencing operations by Mar’23 would attract only 15% income tax (+ surcharge) rather than the current tax rate of 25.2%. We believe that this is an opportune strategy (neutral if denied tax benefits) and is likely to be replicated by other consumer companies as the tax exemptions in North East and Himalayan States end in a few years. Our capital goods analyst, Renjith Sivaram, also believes that if this trend is followed by other cash rich companies, it could support revival of private sector capex. Our relative positive view of HUL is intact; HOLD reflects the requirement of lower multiples to turn more constructive.
* New subsidiary to avail lower income tax rate: HUL board approved setting up of a 100% owned subsidiary with an authorised share capital of Rs20bn. The official statement from the company is “to leverage the growth opportunities in a fast-changing business environment and will help HUL in becoming more agile and consumer-focused.” We believe that HUL is likely to use this subsidiary to invest in manufacturing facilities to avail tax benefits – 15% + surcharge life-long tax rate rather than 25.2% currently. The company is also likely to use this subsidiary to manufacture high growth categories and import substitution.
* High asset turn businesses likely to follow similar strategy: We note that the Staples companies are generally cash rich (barring GCPL and JLL in our coverage) and have high asset turns (see figures 1-2). This means that these companies have both the ability to set up and utilise any additional capacity. We further believe that as the tax exemptions in North East and Himalayan States end in a few years, the consumer companies are likely to look for the opportunity to lock the tax rates to 15% + surcharge from the new manufacturing facilities.
* Private capex could revive: Our capital goods analyst, Renjith Sivaram, believes this setting up of manufacturing facilities could potential support the revival of private sector capex and could result in improvement in demand for capital goods companies like L&T, Siemens, ABB, Cummins and Thermax.
* Valuation and risks: Our HUL estimates are unchanged; modelling revenue / EBITDA / PAT CAGR of 13% / 14% / 15% over FY20-22E. We maintain HOLD with DCF based target price unchanged at Rs2,100. At our target price, the stock will trade at 47x P/E multiple Mar-22E. Key downside risks are deceleration in consumption demand and pressure on margins from irrational competition.
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