Ind-Ra: Deleveraging led by Metals, Broad-Based Recovery to Take Longer

India Ratings and Research (Ind-Ra) expects Corporate Outlook for FY19 to remain stable, driven by profitability improvement in FY18, leading to deleveraging. However, the improvement remains restricted to the metals sector and a broader recovery could take much longer. The agency expects revenue to witness high single-digit growth (7%-9%) and EBITDA to grow at 8%-11% in FY19 due to pick-up in demand in consumption-led sectors such as automobiles and retail, low base effect and higher realisation in commodity-linked sectors. However, export-linked sectors such as pharmaceuticals and information technology are expected to face challenging times, amid the turbulent international trade environment.

Further, Ind-Ra expects commodity prices to remain relatively higher during 2018 than 2017, thereby having a varied impact on Indian corporates. Higher interest cost and working capital requirement, coupled with the high commodity prices and further depreciation in rupee could neutralise the benefit of improved EBITDA growth during FY19.

Possible Bottoming Out of Stressed Corporates: Ind-Ra analysed the financial health of top 500 non-financial corporate borrowers and the key risks that are likely to impact their credit quality. The list excludes non-banking financial corporations, banks and financial institutions. These corporates accounted INR44 trillion of debt (about 78% of total debt of non-financial corporates) and INR55 trillion of revenue in FY17. Of the sample set, 47% of the corporates were in the non-stressed category (interest cover above 1.5x) in FY17, and are likely to drive recovery in FY19. Moreover, the proportion of stressed corporates (interest cover below 1.5x) reduced to 53% in FY17 (FY16: 54%).

Concentration of Profitability in Oil and Metals Sectors: As per Ind-Ra's assessment, companies in the oil and metals sectors are expected to be the major contributors to EBITDA growth in FY19. Oil companies are likely to register 13%-15% yoy EBITDA growth in FY19 (FY18 (Provisional): 12%-14% yoy, FY17: 18% yoy) and metals companies to record a 10% yoy growth (53% yoy, 48% yoy). Meanwhile, companies in other sectors are expected to register 6%-8% yoy EBITDA growth in FY19 (FY18P: 2%-4%, FY17: negative 1%), bringing the overall growth to 8%-11% in FY19 (FY18P: 10%-12%, FY17: 8%). However, rising oil prices could deter the profitability growth.

Capex Unlikely to Revive until FY20: With an expected rise in capex post FY20, EBITDA growth will remain limited, with the only triggers being the ongoing consumption and possible revival in merchandise exports. Data from Centre for Monitoring Indian Economy suggests a 209% yoy rise in stalled projects in 4QFY18 (government projects: up 95% yoy, private projects: up 314% yoy) and a 49% yoy decline in new project announcements (down 59% yoy, down 42% yoy). Infrastructure, metals and mining, and power sectors, which registered high leverage (9x-10x) and significantly lower capacity utilisation of 20%-30% in FY17 from the peak FY06 levels of 80%-90%, could lower capex spending over FY18-FY20 compared with oil, automotive and telecom sectors. Low plant load factor and decline in power purchase agreements led to a 2% yoy reduction in private sector investments in the power sector. Ind-Ra expects capex spending by top 200 asset-heavy corporates to increase at a CAGR of 5%-8% over FY18-FY20 (FY17: up 5% yoy, FY16: up 4% yoy), primarily in the form of maintenance capex.

The agency believes, given the focus on fiscal rectitude, the ability to propel private investment by way of spending by central government is likely to remain limited. However, in recent years, the role of states has become more prominent in terms of absolute spending. Nonetheless, the central government will continue to reinvigorate private capex spending by way of facilitating various policy oriented reforms.

EBITDA Growth Decelerated Across Rating Categories: Although EBITDA growth decelerated across rating categories, it remained positive for majority of the investment-grade issuers ('IND BBB-' and above) in FY17. Nearly 73% of the investment-grade issuers registered positive EBITDA growth during FY17. Conversely, around 90% of the non-investment grade issuers ('IND BB+' and below) registered a decline in EBITDA over FY12-FY17. Thus, any meaningful recovery would be conditional upon strong economic recovery or structural changes.

Elongating Working Capital Cycle: Ind-Ra expects the working capital cycle to further deteriorate (FY17: 90 days, FY11: 70 days), given the impact of the implementation of the Goods and Services Tax regime and an initial pick-up in economic activities. Sectors such as oil and gas, metals, and chemicals could witness elongation of working capital cycle with rising commodity prices. However, auto and auto ancillary sectors with strong demand will continue to have a stable working capital cycle.

Key Risks Impacting Credit Quality: Sharp rupee depreciation and rise in commodity prices could destabilise domestic financial market, particularly interest rate, thereby affecting debt service ability and incremental capex. Ind-Ra conducted a sensitivity analysis of impact on corporates in scenarios of 50bp, 75bp and 100bp rise in interest rate. It was observed that about INR1.2 trillion debt would move from non-stressed to stressed category with an 100bp rise in interest rate and interest cover would fall by 14.5%.

The agency also analysed the impact of rupee depreciation on the top borrowers with an interest rate shock of 75 bp and observed exporters to witness 5% and 9% rise in EBITDA with depreciation of 5% and 10%, respectively, from FY17 levels (importers: negative 7%; negative 11%). However, the gain in EBITDA for exporters would be offset by the rise in interest cost with their interest cover declining 9% and 6%, with rupee depreciation of 5% and 10%, respectively. Ind-Ra believes the non-stressed corporates would be able to absorb such shocks of rupee depreciation and interest rate rise with a moderate revenue growth of 8%-9%. On the contrary, the stressed corporates would find it difficult to cope up in case of a further rise in the interest rates or a fall in rupee, thereby derailing the overall recovery.

While rising interest rate risks and currency risks are manageable on a standalone basis, both these risks combined could impact recovery substantially. Rise in global trade protectionism and duty hikes, and constrained ability of banks (primarily mid-sized public sector banks) could pose threat to a further improvement in profitability and credit profile of the corporates.

Funding Challenges: Given the limited ability of banking sector owing to burgeoning provisioning requirements, Ind-Ra believes credit rationing is likely to be more prevalent in FY19. Highly rated corporates would have better access to finance at a favourable cost than lower rated entities. The agency expects a modest credit expansion of 8%-9% for public sector banks as many large sectors are burdened by high leverage and low capacity utilisation, and are unlikely to witness material new project launches. Moreover, access to capital market will be favourable for high rated entities in a rising interest rate scenario. The agency does not envisage any compression in spread because of an improvement in the overall financial health of the corporates in the near future.

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