Tax cut widens gap between high fliers and laggards in corporate earnings

There has been a widening gap between high-fliers and laggards on the bourses and in corporate performance during the last few years. This gap has now reached a new high after a cut in corporate income tax in September 2019, according to the quarterly results of listed companies.
 

The 10 most profitable companies accounted for 46.1 per cent of all net profits of listed companies during the quarter ended December 31, 2019. This is up from 42.1 per cent a year ago and the three-year average of around 41 per cent. 

In the July-September 2019 quarter – when the tax cut came into effect – the top 10 companies accounted for 46.3 per cent of all net profits. This is the highest in at least three years (see the adjoining chart).

The effective tax rate for listed companies was down to 29.7 per cent (pre-tax profit) during the October-December 2019 quarter from 37.5 per cent a year ago. Analysts see it as a natural fallout of the earnings polarisation before the tax cut.

A back of the envelope calculation suggests that these top 10 companies cumulatively saved nearly Rs 10,000 crore in taxes in the last two quarters. They accounted for nearly 40 per cent of the combined tax savings of 3,406 companies in Business Standard’s sample.

The effective tax rate for 10 most profitable companies declined to 21.1 per cent during Q3FY20 from 26.8 per cent a year ago. The calculation is based on the decline in their tax rate in Q2FY20 and Q3FY20 from the rate during the corresponding quarters a year ago. 

The analysis excludes public sector banks, telecom companies and firms with large exceptional gains & losses in the past such as Tata Motors, Tata Steel, Vedanta and Piramal Enterprises.

Among individual companies, Reliance Industries tops the list having saved around Rs 2,300 crore in taxes in the last two quarters. It is followed by HDFC Bank (tax savings of around Rs 1,400 crore), HDFC (around Rs 1,200 crore), ITC (Rs 1,050 crore) and NTPC (around Rs 500 crore).

“Tax cut was a kind of fiscal stimulus intended to boost demand and induce firms to do more capex to kick start a new cycle of growth. It would be most effective for gains accrued to manufacturing firms, especially those in the capital-intensive sectors,” said Dhananjay Sinha, head of research at the Systematix group.

The quarterly results, however, suggest that the demand growth is yet to pick up and profits were largely aided by lower taxes and low raw material and energy prices.

The combined net sales of around 2,800 firms (excluding banks, non-banking financial companies, oil sector, Tata Motors and telecom sector) were down 1.4 per cent year-on-year during Q3FY20, the worst show in at least three years. 

In comparison, top line was up 12.3 per cent YoY during Q3FY19. Companies’ combined pre-tax profits (PBT) were down 4.6 per cent YoY, contracting for the third time in the last four quarters. PBT was down 13.7 per cent during the Q2FY20 but up 10.1 per cent during the third quarter of FY19.

Tata Motors reported an exceptional loss of around Rs 27,000 crore during Q3FY19 while mobile operators such as Airtel and Vodafone reported record losses in Q2FY20 on account of the adjusted gross revenue (AGR) liability. Their inclusion skewed the numbers, resulting in 32 per cent YoY growth in PBT and 41.3 per cent YoY growth in net profits.

The sample companies’ combined net profit was up 2.3 per cent. Adjusted for exceptional gains (in other income), net profit was down 6.8 per cent YoY during the quarter, its worst show in 10-quarters.

The effective tax-rate declined to 23.6 per cent during the October-December 2019 quarter, down nearly 600 basis points on YoY basis. 

On basis points is one-hundredth of a per cent. This translated into total tax savings of around Rs 6,800 crore for the sample companies, boosting their net profit by around 8.3 per cent during the quarter. For the entire sample of 3,406 companies, tax savings work out to around Rs 15,000 crore during Q3FY20, boosting earnings by 12.4 per cent.