Ind-Ra: Earnings Recovery to FY12 Levels to Take Two to Three Years; Public Investments Critical in the Interim

India Ratings and Research (Ind-Ra) expects the EBITDA growth of BSE 500 corporates to range between 12%-14% for FY17 under a hypothetical scenario of fiscal loosening, compared to the 5%-6% growth expectation for FY16 (1HFY16: 4%; FY15: 3.5%). However, fiscal loosening is not Ind-Ra's base case under which EBITDA growth rates may remain in a single digit for FY17.

Ind-Ra expects the EBITDA growth to be slightly ahead of nominal GDP growth in FY17. However, a sustained improvement to the post global financial crisis period (FY10-FY12) growth of 17%-22% is unlikely till FY18-FY19 and the growth in EBITDA will also remain below the median growth of 17.5% over FY01-FY15.

To achieve an earnings recovery, an improvement in nominal GDP in FY17 would be required. However, any growth in earnings is likely to remain lower than the FY12 levels given the decade-low nominal GDP growth of 7.4% recorded in 1HFY16, and the expectation of only a marginal improvement in real GDP as well as of softening in commodity prices over the next 12-18 months.

The growth in profits in FY17 to an extent would be driven by increased government deficit (including state and centre) which would need to grow in double digits from the single digit growth of 2.2% in FY15 and mid-single digit expected in FY16. However, Ind-Ra's base case suggests that single-digit growth in deficit could result in earnings growth falling below 10% in FY17.

Gross fixed capital formation (28.7% of nominal GDP in FY15) growth has been 5%-7.5% over FY13-FY15 after growing in double digits over FY04-FY12. Ind-Ra expects growth in profits to be supported by higher public spending; however, private investments may remain lackluster until FY18-FY19 given the sizeable unutilised capacity and leveraged balance sheets of corporates in India.

In nominal terms, private final consumption expenditure (PFCE: 60% of GDP) growth of 11.3% yoy in FY15 (lowest in last 10 years) had an impact on corporate profitability. Given that urban and rural consumption (to an increasing extent) depends on industrial growth and improves with a lag, FY17 is unlikely to show a meaningful improvement in earnings given the dull industrial growth in FY16. However, the outlay on the Seventh Central Pay Commission (1.4% of PFCE, 23.55% increase from FY16) is likely to provide some fillip to this.

Weakness in exports due to the fall in global commodity prices and currency depreciation would continue to pressure profits. India's exports fell by 0.4% in FY15 and 13.1% yoy over April-November 2015. Ind-Ra expects merchandise exports to post mid-single-digit negative growth for FY16, but a marginal uptick in FY17 driven by the base effect.

Ind-Ra expects investment and commodity prices linked sectors to post muted EBITDA growth in FY17. Growth in sectors such as metals and mining (including volumes) and upstream oil & gas sectors would remain muted despite the base effect. However, the downstream oil & gas (refining) sector is likely to exhibit positive growth driven by the higher volume offtake of petroleum products and sustained refining margins. The top five sectors including auto and automotive suppliers, power (generation, transmission and distribution) and telecom contribute 55%-60% to the overall EBITDA of BSE 500 corporates, and any meaningful recovery in overall corporate profits would have to be driven by these sectors.

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