Revival path: Credit quality of key sectors unscathed, outlook on the mend

If 2020 began on an ominous note, it appears to be ending with flickers of light. Things have started looking up. Though the pandemic is far from over, the race to deliver vaccines holds out hope. Key sectors are on the path to recovery as business activity has almost reached pre-pandemic levels. Indeed, while this fiscal will be written off as a year of decline, next fiscal promises to be the one of revival, as demand has begun rebounding. Our credit outlook for eight key sectors in fiscal 2022 gives reason for some cheer. These are core investment linked sectors (steel, cement, power), consumer discretionary (auto, textile, real estate) and essentials (pharma and telecom). Taken together, these represent Rs 9 trillion of CRISIL's corporate sector rated debt. We expect profitability in steel and cement to recover from second half of this fiscal on the back of a pickup in volumes and higher realisations. Moderate capex and improved cash accruals, beckons stable credit outlook for these sectors.

On the other hand, credit outlook for power generation companies would remain 'stable to positive', aided by supportive regulatory environment and demand recovery from industrial and commercial consumption. The demand for passenger vehicles and two wheelers is on an improving trend over past 2-3 months, led by preference for personal mobility. We see a broad-based recovery and stable credit quality on the back of pruned capex and healthy balance sheets. Despite AGR liabilities, credit profile of telecom companies would also remain stable, supported by tariff hikes, and moderate capex and equity raising by players. 

Even textiles, severely impacted by the pandemic, is likely to see recovery, driven by an improvement in both, domestic and export demand.  Credit metrics would rebound and keep the sector credit outlook stable. 

For pharma, a bounce back in domestic formulation sales, continued healthy exports, and improved cost efficiencies should help maintain healthy profit margins and keep credit profiles stable next fiscal. Caution, however, persists in real estate, where recovery is capped due to weak investor sentiment. Credit profiles of small-to-mid-sized and large leveraged developers may remain weak next fiscal as end-users gravitate towards well-established players with a strong track record.

In the first part of the series, we are looking at the core investment-linked sectors.

Steel: On a road to recovery

Steel demand is expected to grow by more than 10 per cent in FY22, on a lower base due to the pandemic induced lockdown in FY21 and improving end-user demand in automobile and construction sectors.

The improving domestic demand is already supporting healthier realisations, leading to a 50-100 bps increase in operating margin by FY22 from the already strong levels of 21-22 per cent currently. Realisations in the second half of FY21 will find support from the cost-led push, due to higher iron ore prices amid supply issues. Currently, domestic HRC prices are at a multi-year high of around Rs 50,000 per tonne, but still at a discount of 5 per cent to the landed cost of imported steel. Prices for steel and iron ore may ease from the current levels, as iron ore supplies increase while coking coal prices remain subdued in FY22.

Higher volume and healthy margins will improve the cash accrual of players, boosting the interest coverage closer to the highest levels seen in past six years. Along with moderate capex projected for FY22, we expect the gross debt to remain steady, supporting a stable credit outlook for the sector.

Cement: On solid foundation

Cement sales volume may grow up to 10 per cent in FY22 on a lower base of FY21, when it is expected to decline between 3 per cent and 6 per cent. This is on the back of infrastructure investments, an uptick in urban housing, and continued monsoon-driven growth in rural markets.

Volume rebound, healthy realisation and benign coal/ pet coke prices may support steady and strong profitability in FY21. The aggregate operating margin of the top 16 cement players (which account for 70 per cent of installed capacity) may scale an eight-year peak of over 22 per cent in FY21. The margin may remain above 20 per cent in FY22 too, given strong demand fundamentals.

This phase of robust profitability and limited capital expenditure will help players enjoy a comfortable financial leverage (net debt-to-Ebitda) of around 1.5x in FY22. This is similar to the levels seen before the pandemic in FY20. 

Players may see an improvement in their credit metrics; primarily, their interest coverage is expected to rise to an all-time high of more than 6x. As a result, CRISIL believes the credit outlook for the sector will remain ‘stable’.

Power: Atmanirbhar Bharat, coal on credit to aid credit outlook

Electricity demand may grow 5 per cent in FY22 on a lower base of FY21, when it is expected to decline 2-3 per cent on-year. This will be driven by an expected economic recovery and consumption from the industrial and commercial segments. Power demand rose 4 per cent on-year during the four months to November 2020, as against a 5 per cent on-year decline for the first eight months of CY20. 

The improvement in power demand will help improve the PLFs (plant load factors) of thermal generation companies from an expected 53 per cent in FY21 to 57 per cent in FY22, with capacity addition to be limited and only expected from state and central thermal gencos. 

However, in the renewables segment, strong capacity addition is expected between FY21 and FY23, due to the already auctioned pipeline and continued global investor interest.

Credit outlooks are expected to be ‘stable to positive’ for gencos and ‘positive’ for private thermal gencos, driven by the government’s Atmanirbhar Bharat package and coal availability on credit from Coal India, which will enable a cumulative liquidity support of Rs 40,000 crore in FY21.

(The author is senior director & head analytics, CRISIL Ratings)

Next: Auto, textile and real estate