Companies raised revenue and squeezed costs in the past two quarters, analysts said, resulting in significant operating leverage
Steady earnings growth boosted Indian companies’ ability to service debt in the December quarter despite a higher interest outgo, an analysis of corporate earnings showed.
Companies raised revenue and squeezed costs in the past two quarters, analysts said, resulting in significant operating leverage. As business rebounded, working capital requirements grew as well, leading to a higher interest outgo.
A Mint analysis of Capitaline data showed that the interest coverage ratio (ICR) of 324 companies in the BSE 500 index rose to an 11-quarter high of 4.46 in the December quarter, compared with 3.87 in the September quarter and 3.30 in the December quarter of the previous fiscal. The ratio is derived by dividing a company’s Ebitda (earnings before interest, taxes, depreciation and amortization) by its interest cost. A higher ratio indicates a better capability to pay interest from operating earnings. The analysis excludes banking, financial services and insurance (BFSI) and oil and gas companies as they follow a different business model.
According to Avneesh Sukhija, a senior financial analyst at BNP Paribas India, the reopening of the economy helped companies across sectors recover to pre-pandemic levels. He said that the most stressed sectors such as steel, construction, real estate and manufacturing reported sales that were near or back to pre-pandemic levels, while indicators such as passenger vehicle sales, freight traffic, electricity demand and real estate volume offtake started reflecting normalcy in Q3. “Cash flow was back in the system, implying sufficient liquidity and, to a certain extent, lower receivables. In our view, all of the above combined had a significant impact on companies’ debt-servicing ability," Sukhija said.
Interactions with the regional heads of various banks suggested that promoters had started monetizing their non-core assets to meet debt service obligations, Sukhija said.
Most large private banks in BNP Paribas India’s coverage reported a significantly low restructured book—less than 100 basis points (bps) in the December quarter as against the average phase-two moratorium book of 17% for key banks.
Companies also dipped into savings to service debt, Sukhija said, given greater clarity on cash flows as the broader economy gathered steam.
“Given that the moratorium expired in August 2020, the Q3 ICR is an indication of interest cover without the benefit of the moratorium, showing an improving trend. Nonetheless, given that the improvement in ICR was partially driven by earnings improvement on the back of cost-cutting measures, etc., this can moderate to some extent going forward. Additionally, with commodity headwinds emerging, there can be further pressure on earnings, which will again lead to some moderation in ICR over the near to medium term," said Shamsher Dewan, group head-corporate sector ratings at ICRA Ltd.
Adjusted net profit growth (for one-time loss or one-time profit) of these 324 companies was at a 25-quarter high of 50.13% in Q3FY21, while net sales growth was the highest in seven quarters at 7.99%.
Despite low interest rates, interest outgo rose due to greater working capital borrowings. Interest paid by these companies grew 6.89% from a year ago in Q3, the highest quarterly growth in this fiscal. In the September quarter, it was down 2.09% while it was up 12.44% in the December quarter of the last financial year.
According to bankers, an increase in production in the December quarter led to higher utilization of existing working capital limits. In fact, the Reserve Bank of India (RBI) pointed out in its February policy that capacity utilization in the manufacturing sector in the second quarter of this financial year was at 63.3%, up from 47.3% in the preceding quarter.
Experts said this trend continued in the December quarter. “There is a direct correlation with capacity utilization. That leads to companies drawing higher working capital, and it does not mean fresh capex is happening," said a senior banker at a private sector bank.
The banker added that when working capital utilization goes up, interest cost goes up. “It is not like they have taken new loans; it is only the utilization of existing limits that has led to this," he said.
Other experts said the rise in interest cost is not surprising and is in line with the credit growth in the same period.
To be sure, interest cost has remained benign in Q3 as well, with RBI sticking to its easy money policy.
The central bank has lowered its repo rate by 115 basis points (bps) since March 2020, and even while trying to wean the economy off this liquidity, it assured the markets of continued support.
“Bank credit grew by 6.7% year-on-year as of December 2020. Corporate bond outstanding likely grew in double digits. Put together, this could tie-in with the 6.9% year-on-year growth in interest costs that you see, despite lower interest rates," said Ananth Narayan, associate professor at SP Jain Institute of Management and Research.
The central bank has projected the economy to expand 10.5% in the coming financial year of 2021-22 based on its reading of strengthening growth impulses that include higher capacity utilization and energy demand.