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China restaurant stocks will look appetising when tax reform kicks in

PUBLISHED : Tuesday, 22 March, 2016, 4:26pm
UPDATED : Wednesday, 23 March, 2016, 10:37am

The soon-to-be implemented business tax would come as an extra cost to China’s construction sector but the impact on most related stocks is expected to be limited.

The Value Added Tax (VAT) that replaces the old Business Tax (BT) is part of a major tax reform in China. May has been set as the deadline for switching from BT to VAT in the remaining four sectors – construction, property, finance and life services – that still operate on BT.

For years, China operated a dual system of indirect taxes, with VAT applicable only to a limited amount of goods, typically at the rate of 17 per cent. Most services were subject to BT at rates of 3 or 5 per cent.

Credit Suisse believes the VAT scheme will hit China’s construction sector the most.

“As a large proportion of construction costs are not eligible for VAT deduction, including labour, locally purchased raw materials and certain subcontracted orders, most construction firms are not able to pass through the incremental cost to their clients,” said Credit Suisse research analyst Edmond Huang in a report.

However, the tax reform will have very limited impact on Chinese banks, according to Credit Suisse.

Vincent Chan, head of China research Credit Suisse, said in a report that total earnings of MSCI China may suffer only by 0.22 to 0.43 per cent in 2016, according to the bank’s estimate.

“The negative impact is very limited mainly because the earnings of banks, which have the largest weight in MSCI China, will only suffer negative influence by less than 1 per cent,” said Chan in the report.

Mandy Chan, head of China & Hong Kong equities at HSBC global asset management, agrees that despite a higher tax rate faced by Chinese banks as a result of VAT, the actual burden depends on the deductible items due to be announced soon. But the impact on the sector could be modest and manageable, she said.

In contrast to the construction sector, Credit Suisse said, China’s consumer stocks should benefit the most as a result of the tax reform, followed by car makers and dealers.

Kevin Yin, research analyst at Credit Suisse, said in the same report that he expects consumer sectors including catering and lodging that are paying 3 to 5 per cent business tax, to benefit from the tax policy change while the impact would be marginal for most consumer goods manufactures who have already been paying VAT for years.

Credit Suisse’s sensitivity analysis indicates a nearly 15 per cent upside in 2016 earnings per share for Chinese fast-food hot pot chain Xiabu Xiabu and multi-brand hotel group China Lodging.

“Food materials, the largest cost, are expected to become deductible,” according to Yin. “In theory, it could result in earnings rising post-VAT, but this assumes smooth implementation, good recovery of deductibles, and no pass-on from food manufacturers.”

Yin believes stocks likely to outperform are JD, Anta Sports, Haitian and China CTTS, while the least favoured stocks are Tingyi, SaSa, China Modern Dairy, and Hengan.

Credit Suisse research analyst Bin Wang wrote in the report that auto dealers would benefit more from VAT reform as they have higher financial leverage than original equipment manufacturers (OEMs)among Hong Kong-listed companies. BYD is the largest beneficiary among OEMs, according to Wang, as it has a larger amount of debt and higher financial leverage than other car makers.