INDIAN FIRMS STRUGGLE TO COVER INTREST

the risk to corporate earning growth has increased

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26 August 2013

Indian firms struggle to cover interest cost

There’s a clear weakness in companies’ ability to service rising loan books across core sectors

Vatsala Kamat

First Published: Sun, Aug 25 2013. 08 55 PM IST

With the economy showing no signs of a recovery, the only other option for companies is to remove debt on balance sheets by selling assets. Photo: Mint

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Updated: Sun, Aug 25 2013. 11 39 PM IST

The risk to corporate earnings growth has increased as the debt servicing ability of domestic companies has deteriorated. The past eight quarters have seen a steady decline in the interest cover (operating profit to interest) ratio, even as companies’ revenue and operating profit were barely sufficient to offset the pressure of rising debt and interest costs.

There’s a clear weakness in companies’ ability to service rising loan books across core sectors like construction and infrastructure, capital goods, real estate and even cement, according to a Mint analysis. The capital goods sector’s interest cover has fallen between June 2011 and June 2013 from four to 1.1, primarily due to slowing sales and poor operating profit growth. Also, hospitality firms, which borrowed heavily to fund expansion, are wedged between slowing revenue growth, overcapacity and high interest cost outflows. Their interest cover ratio has halved to 0.9 in the period.

Not surprisingly, infrastructure firms have borne the brunt of the economic slowdown and liquidity crunch. Slower project execution translates into poor revenue growth. Higher working capital and the resultant interest cost increase squeezes profits. Cement and real estate firms, too, are no exception, as companies in these sectors have built surplus capacity mostly with the help of loans.

With the economy showing no signs of a recovery, the only other option for companies is to remove debt on balance sheets by selling assets. Gross debt has risen by nearly 24% year-on-year in the fiscal year ended March, according a Credit Suisse report titled House of Debt, which looked at 10 large infrastructure groups in India.

“For most of these groups, debt increase has even outpaced capex increase,” the report said. Asset sales have not been able to trim debt sufficiently to offer a breather from high interest cost outflows that obviate profit growth. Further, given the liquidity crunch in the economy, large asset sales are not happening.

Six-monthly data shows net debt at the end of March shot up by 22% for construction firms, 40.6% for capital goods firms and 27.9% for infrastructure firms. Even the benchmark Sensex and diversified BSE 500 aggregate net debt has jumped by 16% and 17%, respectively.

At this juncture, unless there is a strong demand pull-back across sectors, earnings downgrades through the year are likely, except for export-driven sectors like information technology. “Even the 8-10% forecast in earnings growth for fiscal 2014 looks optimistic,” brokerage Edelweiss said in its corporate results review of the June quarter.

First Published: Sun, Aug 25 2013. 08 55 PM IST