'Midcap, smallcaps look attractive after tax cut, but be selective as credit cycle yet to improve'

Banks and MNC companies are the biggest beneficiaries of the corporate tax cut. Also, this step has the potential to get our growth trajectory back to 7 percent which ultimately will help every company," Shailendra Kumar, Chief Investment Officer at Narnolia Financial Advisors said in an interview to Moneycontrol's Sunil Shankar Matkar.

edited excerpts:

Q: What are your thoughts on the government's move to cut corporate tax?

A: For the last 6 quarters, the Indian economy has grown below its potential owing to multiple issues and now the GDP growth rate has come down to 5 percent. The government has been pushing monetary, regulatory, administrative and fiscal stimulus to get the economy back to its potential growth rate. In that series, the current step of drastically reducing corporate tax rate is like a 'brahmastra' to destroy economic pessimism. It surely will be counted among major reforms in the economic history of India.

Shailendra Kumar

Chief Investment Officer|Narnolia Financial Advisors

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Q: What do you think would be the impact of corporate tax cut on earnings in FY20? Which sectors or stocks will see major earnings upgrade?

A: In the very near term, this measure will increase the net profit margins of Indian corporate. And that will result in earning estimate of Indian corporates. We have upgraded our Nifty EPS estimate for FY20 from Rs 560 to Rs 597. There would be earning upgrades for a very large number of companies. The major upgrade would be for banking companies and MNCs.

Q: Do you expect the upward momentum to continue going forward and can we hit a fresh record high by Budget 2020? What are levels you see for Sensex and Nifty by Budget 2020?

A: If one does a straight translation of this 10 percent cut in the tax rate, one would be tempted to assume 12-14 percent higher growth for earnings. Though looking at demand slowdown and subsequent requirements by corporate for using price elasticity to increase sales, we believe 8-10 percent direct translation in terms of EPS upgrade looks more realistic.

So for similar multiple, a rally of similar magnitude is warranted. We also believe that while market rally during Modi 1.0 was about PE multiple expansions, during Modil 2.0 most of the market gains have to come from earnings growth. And here if the reduction in the tax rate changes the basic trajectory of the economic growth which we believe is a very high probability bet, we are set for an earning upgrade cycle and upside could be way larger. We have increased our Nifty target from 11,700 to 12,300.

Q: After removal of buyback tax for companies which announced buyback before July 5, do you expect more buyback offers to hit Street?

A: Sure, it will help to companies that had announced buyback before July 5. But we believe dividends are a smoother way of the distribution of profits than buyback as the small passive long term investor does not participate in the buyback process. For us, the larger demand is the removal of dividend distribution tax going forward.

Q: Which companies or stocks that are likely to benefit the most from the slash in corporate tax rate? What are stocks to pick for next one year?

A: Banks and MNC companies are the biggest beneficiaries of the move. Also this step has the potential to get our growth trajectory back to 7 percent which ultimately will help every company. We are recommending HDFC Bank, SBI, ICICI Bank, United Spirits, D-Mart, Infosys and UltraTech Cement.

Q: What are your views on the government which has been proactive at every front to boost the economy and put India back on the $5 trillion economy mark?

In a global context, our potential is humongous. Not only we are a large consumer market but our capabilities to build businesses both in services and products to serve the world through selectively proven are still under-delivered. Per capita consumption of most of the products and services in India remains very low and has the potential to scale much higher. So this $5 trillion is an assured space for India.

The key question is how many years we would take to reach there. Recently our growth rate has de-accelerated a lot but these latest tax measures would surely help in speeding up our journey. The government needs to remain committed to further reform. We require real large divestment. Further measures are needed in terms of improving the rural economy. Factors reform in terms of land and labour is also desired to get Indian economy to grow to its latent potential.

Q: Do you think FII flows would reverse following the announcements and will it cross more than Rs 1 lakh crore for FY20?

There will be an improvement in FDI is a near certainty, a boost to make in India would also be expected. If SME, MSME improves, HNI participation would come back in the stock market. FII flows are dependent on multiple issues. Tax measures surely improve the relative attractiveness of the Indian market which we were losing lately due to growth slowdown.

Q: Do you advise buying midcaps now or be in wait n watch mode for some more time?

Mid and Small Cap is a good space now to start looking into. During the middle of 2017 when interest rate had started moving up, we had become bearish in this space. Fall in the interest rate and a sharp valuation correction now is key reason why we are becoming hopeful in this pace. As most of the companies in mid and smallcap space companies do not have a structural moat, so the stock market performance of these companies remain dependent on the economic cycle. We need to be selective. Credit cycle is yet to improve and many of these companies are passing through disruptive changes in their business model.