Ind-Ra: India Inc Struggles with Leverage; Dis-Inflation A New Risk

India Ratings and Research (Ind-Ra) hosted a webinar today to discuss the bottoming out of leverage of the top 500 Indian corporates. The credit metrics of the largest listed 500 corporate borrowers in India are showing signs of bottoming out, but any claims of a recovery in the system-wide credit profile may be early says India Ratings and Research (Ind-Ra). The median leverage (net debt/EBITDA -earnings before interest, tax, depreciation and amortization) has shown marginal improvement. FY15 India Inc's top corporate leverage (median) is estimated at 4.33x (FY14:4.65x). This is the first time since FY10 that the median leverage has fallen year on year.

However, median interest coverage (EBITDA/interest expense) continues to fall (1QFY16:1.56x; FY15:1.64x; FY14:1.84x). The fall in interest coverage is primarily driven by high interest rates and weak earnings. On average two-thirds of each corporate's EBITDA is going into servicing interest, which is the weakest coverage ratio in over a decade. The top 500 corporates balance sheet debt stood at INR31.99trn in FY15, up 3.9% from FY14. However their interest expense grew at 11.8 % (FY14:2%).

In FY15, the aggregate absolute revenue and EBITDA grew at 1% and 6% respectively. This is the weakest revenue growth since the global financial crisis in FY09. This may be attributed to the disinflation in the economy. The FY15 nominal GDP growth of 10.5% which subsequently nose-dived to 8.8% in Q1FY16 is among the weakest in a decade. To the extent company financials are nominal (ie; not adjusted for inflation) a dis-inflationary environment may have a temporary damping effect on revenue and earnings growth.

Median EBITDA margins may be bottoming out since the rate of deterioration has slowed. EBITDA margins fell to 10.8% in FY15 (FY14:11.4%) and has come down sharply from 14.9% in FY10. However, it may be argued that the quality of earnings may have improved as reflected in the marginal uptick in median cash flow from operation margins and fund flow from operation margins. The proportion of accruals in the earnings has reduced. This is explained by the observation that, highly leveraged corporates met funding constraints to further prop-up their working capital. This curtailed their ability to generate revenue and accounting profit but it improved the quality of earnings. The median working capital cycle of these 500 corporates has also stabilized though around historically higher levels (56 days).

The margin stabilization is not uniform and thus continues to remain worrisome. Despite the moderation in leverage the vulnerability of corporates may have increased in FY15 compared to FY14. The number of corporates with negative EBITDA has gone up to 17% (FY14:12%). Operations of close to half (47% FY14) of the corporates are not generating cash. While the proportion of corporates in extreme stress baskets, defined as corporates who do not earn enough to even service their interest expense, has reduced to 29% in FY15 (FY14:35%), however over 50% of the debt belongs to corporates where the interest coverage ratio is below 1.5x. This is possibly the weakest in over a decade.

Ind-Ra's analysis of leverage and debt by industry suggests that sectors such as auto and chemicals are experiencing the least stress. Most players in the auto sector tend to have lower leverage than other capital intensive sectors. Real estate, FMCG, metals &mining and textile remains the most troubled. Several players in the infrastructure space and real estate have directionally reduced their leverage levels, more often by asset sales, even though on an absolute basis they remain high.

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