Amid slow economic growth, India Inc's return on capital shows improvement

In FY16, return on invested capital for the BSE 500 companies was 10.45 per cent; at the end of FY19, it had improved to 11.55 per cent

Amid the gloom and doom over earnings and economic growth, a key financial metric for India Inc is showing improvement. According to an analysis by Investec, the return on invested capital (ROIC), a metric for assessing efficient use of capital, has been on the rise in the past three financial years.

In FY16, ROIC for the BSE 500 companies was 10.45 per cent; at the end of FY19, it had improved to 11.55 per cent. The increase is even more encouraging if one factors in the falling interest rate. The spread between ROIC and the risk-free rate has gone up from 2.95 in FY16 to 4.95 per cent in FY19 — the highest in eight years. Investec says the improvement is on account of easing of competition.

“Easy, and indiscriminate access to capital in the past had led to irrational competition in most sectors — banking, cement, steel, construction, and others. This was not allowing the sectors on aggregate to even earn cost of capital. As capital becomes more discerning, we see profitability improving. The improvement in ROIC indicates that companies are adding more value today over their cost of capital than any time since FY11, driving stock performance, even as the economy has slowed,” says Mukul Kochhar, co-head of equities, Investec India.

The brokerage feels the efficient use of capital could drive valuations higher. “Stable to increasing ROIC in the face of declining risk-free rates is another cause of valuation expansion, even though in some instances, valuation expansion may have been excessive.” Technology, consumer goods and auto are some of the sectors with the highest ROIC.