Corporate India's interest outgo is growing faster than its operating income. As sectoral issues combine with a slowdown to pull down earnings, servicing debt could become more challenging
In his book How the Mighty Fall, American business consultant and author Jim Collins outlines five stages of decline that even the best of companies could witness - beginning with hubris born of success and ending with the entity becoming irrelevant or dead. But when many mighty companies begin to feel headwinds at the same time, witness credit downgrades, struggle with dwindling profits and rising debt, there is more to the story than just the five internal stages of a giant's decline.
The last two years can well be called the years of the fall of the mighty in India Inc. There is hardly any business expansion or new project, debt overhang is looming large, there have been defaults by those who seemed infallible until this time last year and many are facing bankruptcy proceedings.
Debt papers of companies of billionaires Sunil Bharti Mittal, Ajay Piramal and Mangal Prabhat Lodha besides biggies like Tata Motors, ICICI Bank, Vodafone-Idea and many others have been downgraded by credit rating agencies in the last eight months on the back of weakening financial performance and rising debt levels.
Dhananjay Sinha, Head of Strategy Research and Chief Economist, IDFC Securities
The mightiest in their sectors, IL&FS and Dewan Housing Finance, are now a pale shadow of their peak avatars; Subhash Chandra's Essel Group has been so far unsuccessful in lowering its debt levels and Jet Airways, once India's largest commercial passenger airline, is history. And that's just in the key sectors like telecom, auto, aviation and real estate. "Rating downgrades for large companies are a precursor to what could happen to smaller companies. Smaller players will find credit availability getting tightened and they will be under intense scrutiny by lenders. This will only make the going tougher at a time when liquidity is not easy to come by," says Dhananjay Sinha, Head of Strategy Research and Chief Economist, IDFC Securities.
Not surprisingly, while the operating income of corporate India increased only 7.6 per cent year-on-year in 2018/19, its interest expenses went up by 12 per cent. This indicates that the ability of companies to service debt is not growing as fast as its leverage levels. In the common sample of companies from BSE 500, BSE Mid-cap Index and BSE Small Cap Index (excluding banks, NBFCs, MNCs and FMCG companies), debt went up 10 per cent while net profit grew only 3.8 per cent.
The overall debt of these 800 companies increased from Rs 24.5 lakh crore in 2013/14 to Rs 32.03 lakh crore in 2018/19, a rise of 30 per cent in five years. During the same time, net profit of these companies increased a meagre 10 per cent from Rs 2.44 lakh crore to Rs 2.69 lakh crore.
"It is not that this rising debt is going into capacity expansion. Debt has been inherited and it is now increasing to meet working capital requirements due to slow profit growth in the last few years," Sinha says.
McKinsey also believes that financial stress is building in India, along with the rest of Asia, with increased indebtedness, stress in repaying loans, lender vulnerabilities and shadow banking practices being areas of concern. The value of debt in India, issued by companies with an interest coverage ratio of less than 1.5, has increased from $18 billion in 2007 to $27 billion, creating an alarming situation, it says.
Cost of Money
Magnifying the trend is the fact that banks are not able to pass on the benefits of the RBI's rate cuts to borrowers. While the central bank has cut the repo rate by 2.6 per cent since 2014, India's largest bank, SBI, has reduced its floating rate by only 1.1 per cent. This is also because household savings have been declining, non-performing assets (NPAs) are rising and there is severe liquidity crunch. Borrowing costs and deposit rates are not linked to the repo rate today and so any bank's ability to transfer the repo rate cut to borrowers is limited," says Amit Goenka, Managing Director and Chief Executive Officer, Nisus Finance Services. Further, banks are required to keep liquidity reserves and provision for NPAs, which are still erupting as cost of capital is much higher than the repo rate.
Moreover, in the current scenario of demand for liquidity outstripping supply, there is no incentive for banks to lend at repo rates. "Borrowers in auto, infrastructure and realty (sectors) are willing to pay higher cost of capital to secure credit. And given that NBFCs and housing finance companies are also willing to pay a higher cost, banks don't feel the need to push lower-cost capital," says Goenka.
On an average, the cost of capital has gone up 250 basis points (bps) for companies in one year and 400 bps for realty commercial loans.
Thomas John Muthoot, CMD, Muthoot Pappachan Group, says his company's cost of funding has gone up by 100 bps in the last one year, pushing up interest charges and pulling down growth. "For the last nine months, things have been tough. Banks have not been lending. So, our growth has been impacted. Last year, we were growing at 2 per cent every month and were expecting 25 per cent growth, but in November, we were forced to conserve cash. Overall, we grew only 16 per cent in 2018/19," he says. The company has been "bearing the brunt for almost 12 months" and it was time banks resumed lending after the announcement of the fiscal stimulus package by the government, Muthoot adds.
The rising corporate debt and interest outgo have been coupled with slow growth in profits due to declining sales across sectors. Net profits fell 4.2 per cent in 2017/18 and while they bounced back with 3.8 per cent growth the next year, they are lagging both interest payments (rise of 12 per cent) and tax payments (rise of 20 per cent).
In real estate, sales grew only 1.28 times between 2009 and 2018 to Rs 2.06 lakh crore. But the sector's overall debt increased 3.33 times during the period to over Rs 4 lakh crore. Developers continued to buy land at exorbitant rates, expecting continued boom. "Land prices have increased 10 times in the last 14 years. Developers took debt to buy land, but since sales have remained abysmal, they are finding it difficult to meet their debt obligations," says Pankaj Kapoor, Founder and Managing Director at real estate consultancy Liases Foras.
The story is worse for the telecom industry, where adjusted gross revenues stood at Rs 1.45 lakh crore in 2018/19 (Rs 1.88 lakh crore in 2015/16). The sector is sitting over a debt of Rs 8 lakh crore. The monthly average revenue per user (ARPU) from wireless services was just Rs 71.39 in the March 2019 quarter, less than a fifth of what it was in 2005: Rs 374.
It all began with the high spectrum charges that operators paid during 3G auctions in 2010 - around Rs 70,000 crore. Then there was network layout and expansion. Subsequent spectrum auctions, implementation of newer technologies and cut-throat competition following the entry of Reliance Jio in 2016 compounded the problem.
Moody's cut Bharti Airtel's rating to 'junk' in February while both CARE Ratings and CRISIL have downgraded Vodafone-Idea.
In the steel industry, a global slump is pushing more and more companies towards the Insolvency and Bankruptcy Code (IBC). Lower demand from China and global protectionist measures have led to fall in steel prices. Moreover, the sector's working capital cycle is stretched due to delayed payments and banks' liquidity crunch. As of now, the steel sector's outstanding credit stands at Rs 2.82 lakh crore.
"In the current and next fiscal, we expect the steel sector's profitability to be under pressure in the wake of price or realisation downtrend and rising iron ore costs. Profits will be squeezed more for non-integrated players, which constitute three-fourth of the steel capacity," says Hetal Gandhi, Director, Crisil Research, adding that the profitability downtrend "will have some bearing on the sector's debt prospects."
RC Bhargava, Chairman, Maruti Suzuki
In line with the slump everywhere, the overall auto sales too contracted 19 per cent year-on-year in July 2019, the worst since April 2001. Sales of commercial vehicles, an important indicator of economic activity, were down 25.71 per cent to 56,866 units, while for passenger vehicles, the decline was 31 per cent to 2,00,790 units. "This is the worst year we have had in the last many decades. We have reached the bottom," says R.C. Bhargava, Chairman of Maruti Suzuki, India's largest automobile manufacturer.
For the auto sector, the factors that led to the slowdown are structural (push for electric vehicles, implementation of Bharat Stage VI or BS-VI emission norms from 2020) and transient (rising cost of ownership), besides the overall gloom due to increased job losses and reduced incomes.
"Unfortunately, all the causes have come together in one year," says Bhargava, who is hopeful that the government's stimulus package will bring the sector back on track in the next couple of quarters.
In infrastructure, the power sector is among the worst off. Power Secretary S.C. Garg puts the overall stressed portfolio at around Rs 4 lakh crore.
While power is a capital intensive sector, many entities are not able to realise payments fully and on time due to various concession agreements with consumers, explains Goenka of Nisus "The efficiency of these assets is very low and they are not able to generate sufficient returns on capital. Slow conversion of assets to cash leads to higher debts."
Fall in per unit prices of alternative sources like hydro and solar power in the last few quarters has made them attractive, further affecting the profitability of fuel-based power plants where "input prices have gone up without corresponding rise in output prices," adds Goenka.
In the words of NITI Aayog Vice-Chairman Rajiv Kumar, the ongoing financial crisis in India is "unprecedented in the last 70 years". He said the entire economic situation had changed after implementation of initiatives like demonetisation, GST and IBC, a view echoed by many others.
Crisis of Confidence
Niranjan Hiranandani, Co-founder and Managing Director, Hiranandani Group, and President of the National Real Estate Development Council (Naredco), says the Indian economy is facing challenging times with reduced consumption and liquidity crisis, underscoring an urgent need for solutions. "The set of 'tsunamis' that impacted real estate began with demonetisation, which sucked out liquidity from the system. And while introduction of RERA, or the Real Estate (Regulation and Development) Act, impacted real estate at various levels, what hurt the most was the norm to keep 70 per cent of a project's funds in an escrow account," he says. This resulted in project funds getting blocked. Over 1,74,000 homes in 220 projects are stalled in the top seven cities across India as developers don't have funds to complete them. It will take over 40 months to liquidate the current unsold inventory across the country.
Niranjan Hiranandani, Co-founder and MD, Hiranandani Group
"While banks went slow on lending to real estate, NBFCs were impacted by the IL&FS crisis last year. Now, DHFL has impacted the finance market sentiment. This has resulted in the funding funnel getting choked," says Hiranandani.
In early August, Moody's Investors Service downgraded the corporate family rating of Macrotech Developers (earlier Lodha Developers, the largest player in the residential real estate by sales) to B3 from B2, with a negative outlook. In July, rating agency ICRA downgraded the long-term rating of Rs 350-crore non-convertible debentures of Piramal Realty, driven by the deterioration in the operating environment owing to tight liquidity that may diminish the ability of holding companies to raise funds.
The rating downgrade story is common across sectors in India Inc, and infrastructure has not remained unscathed by this adverse liquidity scenario. Hemant Kanoria, Chairman of Kolkata-based Srei Infrastructure Finance, says that in the last five years, since banks have lost money due to NPA provisioning, regulatory changes or even cancellation of mine leases, they have become cautious regarding lending to the sector. "Given the current liquidity scenario, they don't want to lend to infrastructure. And unfortunately, the NBFC problem has gone into a tailspin and is getting more and more entangled. The entire liquidity in the system has been squeezed - first by banks and then by the NBFC crisis," he says.
If the issues are not addressed and companies are not able to raise profits even though their debt is increasing, there could be a rise in NPAs, warns IDFC Securities' Sinha. "The debt servicing capabilities of companies will diminish and their ability to invest in fixed assets will continue to languish. So any ability to kick-start investment will be impaired, resulting in a vicious cycle," he says.
A McKinsey report points out: "The large share of stressed utilities in India and Indonesia is particularly troublesome because their ability to turn around performance and repay the debt requires working across multiple stakeholders - regulators, consumers, local and national governments, and the companies themselves - making recovery much more complicated for this sector."
Kanoria of Srei Infra Finance says there is an urgent need to channelise liquidity in the right manner. "That can happen only when confidence comes back. People have money, but prefer to sit over deposits in the current economic environment," he says.
With a shallow corporate bond market in India, NBFCs and housing finance companies continue to give long-term loans against short-term funding. Due to their dependence on wholesale funding, any failure to make payments when debt instruments come up for redemption can trigger a crisis. "The government must support the creation of a bond market for additional funding and introduce corporate bonds, sovereign bonds and ECBs (external commercial borrowing)," says Hiranandani.
While Finance Minister Nirmala Sitharaman has announced the government's intent to deepen the bond market, no concrete measures have been undertaken so far. On its part, on August 23, the government announced measures to ease liquidity constraints, with a focus on the worst-hit sectors. Sitharaman announced additional liquidity support of Rs 30,000 crore for housing finance companies, Rs 70,000 crore for PSB recapitalisation, and loan restructuring for MSMEs, besides a host of other measures.
However, the success of these measures will depend on speed of implementation. Almost two months after the Budget, most of the proposals announced remain only on paper. If corrective measures are implemented speedily, it may help defuse the debt bomb that threatens India Inc. Otherwise, the mighty in India Inc may continue to fall.