Mumbai: Indian companies are struggling with mounting interest costs on the back of slowing sales, growing dependence on domestic debt and high interest rates.
A Mint analysis of 2,178 listed firms, for whom data is available for the quarter ended 31 December, shows that interest costs have increased 72% in the past year, denting profitability. In rupee terms, interest costs for these firms rose to Rs15,591 crore in the third quarter of this fiscal, up from Rs9,025 crore in the same period last fiscal year.
Aggregate net profit of these firms for the same period is down by close to one-third—from Rs79,439 crore to Rs53,352 crore. The analysis excludes banks and financial institutions because they are in the business of borrowing and lending money.
Analysts and economists say the economic slowdown will also see a weak fourth quarter ending 31 March, raising fears that some companies might be headed for a debt trap. Also, working capital cycles have lengthened, while foreign lenders have all, but shut off funding, leaving firms depending almost entirely on domestic lenders such as banks who have been reluctant to reduce interest rates.
Also See Interest Burden (Graphic)
In a reflection of new debt and high rates, the interest coverage ratio for these companies slipped to 3.42 for the quarter ended 31 December, down from a healthy 8.80 in the same quarter of last fiscal.
Interest coverage ratio is the number of times a company can pay interest from its available earnings, and is calculated by dividing a firm’s earnings before interest and taxes by interest paid.
“Interest cover ratio will deteriorate,” warned Dipen Shah of Kotak Securities Ltd.
The interest coverage ratio for the firms reviewed has consistently declined over the past seven quarters, as interest rates have risen even as firms have taken on more debt due to a lack of other funding options.
As a result, profitability has been affected. The decline in interest cover ratio has also had an impact on the credit quality of Indian firms.
“There is a pressure on corporate credit quality,” said Raman Uberoi, senior director at ratings agency Crisil, a unit of Standard and Poor’s. “This is happening across companies,” but holds particularly true for real estate, auto ancillary and textile companies, he added.
Recent cuts in policy rates by the Reserve Bank of India (RBI)—which cut its repo rate, or the rate at which it lends to banks, by 350 basis points to 5.5% and the reverse repo, the rate at which it soaks up excess liquidity, by 200 basis points to 4%—have translated into only marginal reductions in rates by lenders. One basis point is one-hundredth of a percentage point.
Analysts expect the full effect of RBI cuts to reflect in corporate profitability only two or three quarters later.
Given low profits and strapped credit lines, companies have had to borrow more because of extensions in working capital cycles. As demand slows, firms are facing an inventory pile-up. The chief financial officer with a manufacturing firm, who didn’t want to be identified because he is not authorized to talk to the media, said debtors are taking longer to repay, leading more to meet operational costs.
D.D. Rathi, chief financial officer for yarn maker Grasim Industries Ltd, agreed that “working capital cycle has extended and its management is top priority”.
Adding to domestic firms’ woes, foreign financial institutions are refusing to roll over old debt or offer fresh credit following the September near-collapse of the global financial system, and an equity market meltdown. With that funding pipeline closed off, domestic banks have emerged as a major source of credit for Indian companies.
According to financial services firm Goldman Sachs, long- term external commercial borrowings by Indian companies fell by more than half in the current fiscal compared with a year ago, while short-term trade credit fell by $8 billion (Rs38,960 crore) from last year, to $2.5 billion in the April-November period.
Goldman analysts Pranjul Bhandari and Tushar Poddar noted in a 3 February report that “in October and November, net external short-term trade credit totalled a negative $500 million”.
Analysts such as Himanshu Varia of Asit C Mehta Investment Intermediaries Ltd say this has had a significant impact on companies in real estate, auto ancillary and textiles, some of whom are finding it difficult to service debt with existing revenues. “Many companies are feeling the stress and some in sectors like real estate are restructuring their debt,” he said.
Real estate firms that depend significantly on borrowings from banks have an interest coverage ratio of 2.55 in the December quarter, compared with 5.03 a year ago.
An interest coverage ratio of less than 1 means the firm is not making enough gross profit to service its debt.
In the December quarter of this fiscal, the number of companies for whom this ratio slipped below 1 stood at 616, or almost one of every three firms considered in this analysis. For the 30 companies that constitute the Sensex, the benchmark index of the Bombay Stock Exchange, the interest coverage ratio is still at 8.99 for the quarter ended December, indicating that these firms have cash and are not hugely dependent on borrowings. However, even for these firms, the ratio was 16.51 in the same quarter a year ago.
According to Crisil’s Uberoi, in the first nine months of fiscal 2008-09, there were three defaults by companies and 35 rating downgrades, compared with only one upgrade. In the past three years, there had not been a single default.
Graphics by Sandeep Bhatnagar / Mint