S&P raises a red flag over increased PSU investment

Increased spending from India’s government-owned firms could lead to a deterioration in their credit quality over time, says an S&P report


The S&P report noted that state-owned firms’ return on capital has declined significantly over the past few years. Photo: Bloomberg
The S&P report noted that state-owned firms’ return on capital has declined significantly over the past few years. Photo: Bloomberg

Mumbai: Rating agency Standard and Poor’s (S&P) on Monday raised concerns over the increased spending from India’s government-owned firms, saying this could lead to a deterioration in their credit quality over time.

“Poor returns on capital investments and increase in leverage could weaken the stand-alone credit profiles of India’s government-owned companies in the long term. It will also increase these companies’ dependence on the government for support,” said S&P credit analyst Mehul Sukkawala in a report.

The report noted that while state-owned firms started from a strong financial position that allowed them to undertake substantial spending, their return on capital has declined significantly over the past few years.

“Returns have declined to about 12% now from about 21% in the fiscal year ended 31 March 2012. They are still better than the 10% for private companies in heavy industry but lower than the about 15% for the overall private sector,” said the report adding that returns for private companies are expected to improve as they have cut back on capital expenditure and are focussing on cutting costs.

Private corporate investment in the Indian economy has been subdued due to high levels of debt and uncertainty over demand conditions. In the absence of private capex, the onus to push investment in the economy has fallen on government-owned firms. While the expenditure may have a short-term beneficial impact for the economy, it may hurt these firms in the long run, going by S&P’s analysis.

“The financial positions of government-owned companies have weakened over the past seven years as capital expenditures rose and profitability fell,” wrote Sukkawala.

“We expect the leverage for government-owned companies to continue to rise due to high spending, while that for the private sector to begin to improve, following strategic and operational measures to deleverage,” he added.

The report also noted that private firms get far more bang for the buck than government firms.

For every Rs.1 increase in Ebitda (Earnings before interest, tax depreciation and amortization) over the past seven years, the top 18 government-owned companies’ capital spending was almost 17x during the same period, showed a study conducted by S&P. The equivalent number for private companies in heavy industry (oil and gas, utilities, metals and mining, capital goods, and infrastructure sectors) was 15x. This ratio was 6x for all private companies put together, the study found.

As part of the study, S&P analysed India’s top 100 corporate entities based on market capitalization.

Among the state-owned firms, Oil and Natural Gas Corp. Ltd. (ONGC) has spent about Rs.2.7 trillion in the past eight years, making it the largest spender among government-owned companies. “ONGC’s Ebitda hasn’t changed and capital spending has only supported in keeping production at a largely stable level,” said the report.

The worst performer among government-owned companies is Steel Authority of India Ltd. (SAIL), which spent Rs.65,000 crore but whose profitability plummeted to an estimated negative Ebitda in fiscal 2016, from Ebitda of about Rs.10,000 crore in fiscal 2009, showed the study although it added that this was partly due to weakness in the steel industry.

The three state-owned oil marketing companies—Indian Oil Corp., Bharat Petroleum Corp. Ltd, and Hindustan Petroleum Corp. Ltd—have spent Rs.2.2 trillion in aggregate over the last eight years. These firms have seen their profitability improve but this is mainly because of domestic oil price reforms.

Not all government firms can be painted with the same brush.

“Government-owned utility companies such as NTPC Ltd and Power Grid Corp. of India Ltd who also consistently incur large capital expenditures, have registered healthy growth in profitability because they have continued to commission new capacity,” the report noted.