Budget measures and stock performance

PRE-BUDGET SPECIAL

"IT is India's showpiece success story. We have to not just maintain its momentum of growth, but continuously encourage it. Therefore, it is proposed that the concessions extended to IT under sections 10A and 10B of the Income Tax Act will continue as originally envisaged." That was Jaswant Singh in his budget speech last year.

In the previous year's budget, the government had reduced the benefit under sections 10A and 10B, such that they would apply to only 90 per cent of a firm's profit.

With the restoration of the 100 per cent exemption clause, it was felt that IT companies would make considerable savings on tax. As a result, the BSE IT index rose 4.3 per cent on last year's budget day.

But did IT companies end up making considerable savings on tax last year? Probably yes, if one were to look at profit made from centres in 10A and 10B zones. However, that break-up is not available, so one has to do with the total tax provision made by IT companies.

In the case of the top three listed players, Infosys, Wipro and Satyam, the cumulative tax provision actually went up from 14.5 per cent of PBT (profit before tax) in FY03 to 15 per cent last fiscal. Taken separately, Infy's tax provision has come down, while that of Satyam and Wipro has increased. But when the budget announcement came, prices of all front-line IT stocks had jumped.

Another sector that had favourable policy announcements in its favour in last year's budget was hotels. Apart from the complete abolition of expenditure tax, the exemption from service tax was continued. There was also a reduction in customs duty on imported liquor.

The number of positive measures led to a 8.6 per cent jump in Indian Hotels' stock price on budget day. But these benefits are not reflected in the company's FY04 financials, in which operating margin fell 200 basis points. This is not to say that the budget measures would not have helped the company.

In fact, the fall in margins is explained by other factors - upgradation work, higher staff costs, an increase in travel and sales and marketing expenses. The simple point is that budget measures alone need not result in an improvement in company's financials.

Take the case of Britannia, which benefited last year from the reduction in excise duty on biscuits from 16 per cent to 8 per cent. After accounting for the change in abatement rate, the gain amounted to 4.3 per cent on MRP. It was estimated that this was too small an amount to be passed on to customers.

After all, 4.3 per cent on Rs 10 pack of biscuits works out to 43 paise, making it difficult to be passed on to consumers. With the company expected to retain much of the gain, profitability was expected to increase. It did increase, by about 50 basis points in FY04, but only because of savings on staff costs. On budget day, though, the stock had jumped up to five per cent intra-day on the news.

Similarly, the excise on cars, utility vehicles and tyres was reduced from 32 per cent to 24 per cent in last year's budget. Mahindra & Mahindra, the market leader in the utility vehicles segment and Apollo Tyres, the leading tyre manufacturer were expected to benefit. It turns out that in FY04, Apollo Tyres' operating margin fell over 300 basis points.

This was because cost of rubber (50 per cent of raw material expenses) shot up, but it's evident that a cut in excise duty alone will not result in an improvement in fundamentals.

In the case of Mahindra & Mahindra, both sales and profit increased, but not much of that has to do with the cut in excise rate. While the tractor division and the three-wheeler segment contributed to growth, the growth in the utility vehicles was driven by the success of the Scorpio and increasing rural demand.

Besides, the drastic fall in interest rates resulted in much cheaper EMIs, making cars and utility vehicles much more affordable for a large section of society.

This is the story almost every time the budget is announced. In 2002, although the Sensex fell 4 per cent on budget day, Hindustan Lever and Tata Tea withstood the fall as excise on tea was cut by half. HLL had another positive in that even the excise duty on personal products was halved.

These measures would have no doubt helped the beverages and personal products divisions, but a look at the company's results in the past two years shows that it has not done much to improve overall performance. The HLL stock now trades at around half the level on budget day, 2002.

In summary, although one can't ignore the implications of changes in direct and indirect tax policies, there shouldn't be an over-emphasis. With analysts and stock dealers lapping up finance minister's every word on budget day, there are bound to be knee-jerk reactions.

Often, as was the case with most of the stocks mentioned above, there is a correction in the stock price in subsequent trading sessions.

It's prudent, therefore, for sensible investors to stay unaffected by all the hullabaloo that happens in the markets on budget day. It's really more important to take a call on a stock based on other important factors that could affect a company/sector.