Can India Inc strong balance sheets nudge investments?

Analysts attribute the increased leverage to improving business environment as India’s manufacturing sector started to rebound after the second covid-19 wave. The analysis covers 184 non-banking and non-financial NSE 500 companies whose financial results for 2021-22 are available so far.

“Some segments are starting to see a strong rebound in capital expenditure," said Sharad Verma, managing director and senior partner at BCG. “In a low interest rate regime, this capex rebound could partly be the reason for these companies to increase debt levels to finance some of the capex."

Higher commodity inflation is also likely to have led to a jump in companies’ working capital requirements.

Debt-to-equity (D-E) ratio, another proxy for leverage, also rose in FY22 in some sectors such as power, metals and mining, automobile and pharma. The power sector saw the sharpest jump in D-E ratio from 0.89 to 1.11 times. For the auto sector, it rose from 0.19 to 0.21. The reasons could vary: for instance, the power sector saw increased investment, while auto faced higher working capital requirements, said Rajani Sinha, chief economist at CareEdge.

Restrictive expansion

Acute business uncertainty and weak demand, both domestically and externally, kept India Inc. low on animal spirits even before the pandemic. For long after the 2008 financial crisis, investments stayed muted globally and companies made assiduous efforts to enhance capacity. However, of late, several sectors have seen some revival due to low interest costs and a commodity boom. Net fixed assets, a proxy for investments, grew 39% in FY22 for metal companies after contracting in the previous year. Chemicals and consumer durables saw a 22% and 20% growth, respectively. Impact will spread across sectors gradually as capex will take some time to come on board.

But will interest rate hikes deter the recovery? “As interest rates rise from the very low levels currently, they will still remain low (relative to earlier levels) for some time," Sinha said. “Moreover, investment decisions won’t depend just on interest rates, but also on factors like demand, supply, and capacity utilization."

Better credit profiles

In an effort to deleverage balance sheets, companies’ ability to service debt has only improved on the back of healthy operating profits. The combined interest coverage ratio (ICR) of the sample rose to 9.2 from 6.4 in FY21 and 5.8 in FY20. The combined operating profit was up nearly 31%, while the average borrowing cost fell 318 basis points. This boosted companies’ credit profiles sharply, with 91% firms reporting ICR above 1.5, up from 89%. Below a ratio of 1.5, companies’ ability to meet interest expenses becomes questionable.

Experts are keeping faith in India Inc.’s ability to service debt and expect it to remain at similar levels going forward. However, some headwinds are arising due to commodity inflation as the burden has only been partially passed on to end consumers, putting a pressure on margins. Even if margins do not improve over a period, companies have enough operating profits to meet their interest expenses, experts argue.

Healthy reserves

All this while, firms have also been building a war chest for future shocks. Amidst the pandemic, companies' cash hoarding jumped 32% in FY21 and 19% in FY22. “Balance sheets for most companies are much stronger than five years ago and many are sitting on pretty sizable surplus reserves," Verma said. Quite a few have high cash-to-market capitalization ratios, and the uncertainties are only expected to make them cling on to the cash for some more time.

“Companies will continue to be conservative on this and how they allocate this capital is the key decision they are looking at," Verma said. Moving further, he expects some impact from interest rates, but still finds a lot of macro-economic indicators very conducive.

(This is the concluding part of a three-part series about corporate India’s recovery from the pandemic and the path ahead. The first part covered companies’ stock market performance, and the second part covered earnings data.)