Upside to corporate profitability limited in FY18: CRISIL

India Inc revenues to grow 8% in 2017-18, highest in five years

Rating and research agency CRISIL said the upside to corporate profitability will be limited in 2017-18 after the 100 basis point (bp) improvement it expects this financial year (FY17). It expects a gradual recovery in top line growth for India Inc, according to its India Outlook, Fiscal 2018 report released on Thursday.

With an estimated eight per cent growth in FY18 sales, Corporate India will miss the double-digit revenue growth mark once again. The rating agency said “single-digit revenue growth seems to be the new normal”. However, this would be the highest growth clocked by the 1,200 companies in its universe after FY2014. 

CRISIL doesn’t rule out the possibility of operating profit margins taking a knock because of increasing commodity prices.

The sectors that are expected to see a deterioration in the EBITDA margin are airline services, FMCG and tyres, with the fall pegged at about 100 bp each, even as the three sectors will see an acceleration in revenue growth to the tune of 400-900 bp. EBITDA is earnings before interest, tax, depreciation and amortisation.

Barring a few sectors, majority of them including the likes of organised retail, pharmaceuticals, IT services, auto and auto components, capital goods, cement and construction will see moderate increase in EBIDTA margin to the extent 0-50 bp. The ones where the margin is expected to rise the most include telecom services, aluminium and oil & gas, with improvement pegged at around 100 bp each, while power sector too should see margin rise by about 60 bp.

CRISIL bets big on three themes – roll-out of the goods and services tax (GST), consolidation, particularly in telecommunications and cement, and low interest rates likely to support growth, if other conducive factors kick in.

For now, the rating agency believes that much of the earnings growth is likely to draw support from the mild economic recovery. CRISIL expects India’s gross domestic product (GDP) to rise by 30 bp to 7.4 per cent in FY18, driven by pent-up consumption demand following demonetisation.

“We expect GDP growth to 7.4 per cent from 7.1 per cent in FY17, driven by a rebound in consumption demand, which got postponed after demonetisation,” said Dharmakirti Joshi, chief economist, CRISIL. A normal monsoon, benign inflation and softer interest rates are expected to aid GDP growth.

The automobile sector led by two-wheelers and tractors, information technology services and construction sector (mainly infrastructure related) are expected to be the pillars of earnings growth in FY18. However, in sectors such as cement and steel, capital expenditure (capex) even over the next five years is likely to be lower than in the preceding five years. “While the demonetisation effect is fading, sectors such as real estate, cement and steel are likely to remain under pressure in FY18,” said Prasad Koparkar, senior director, CRISIL Research.

Cement, in particular, is expected to witness full recovery only in FY19. “It was a double whammy for the cement sector, with both price and volumes declining,” the report mentions.

CRISIL also warns that the commodity cycle, which started turning around about a year ago, will exert pressure on the profit margins of end-use sectors. Private capex is likely to remain subdued in FY18. “Capacity overhang, stretched balance sheets and only a moderate pick-up in demand will mean revival in capex cycle gets deferred to FY19,” says the report.

Beyond the numbers, CRISIL expects three themes to play out in FY18. “GST will be a game changer and can usher in significant efficiencies and benefits in the logistics chain across sectors. Consolidation is another theme that is likely to play out in many sectors driven by diverse factors – intense competition (telecom, cement), GST and other policy action, and increasing formalisation of the economy (real estate, micro, small and medium enterprises-dominated sectors), and impetus to stressed assets resolution (mainly power and steel),” the report said. Lower interest rates may also help revive the investment cycle, if other factors are also conducive.

As for the banking sector, CRISIL feels the asset quality of Indian corporates is on a mend, showing signs of gradual recovery. This is being driven by firm commodity prices, effects of sustained structural reforms, improving capital structure and lower interest costs. This should bring a turnaround in some commodity-linked sectors, especially metals and mid-sized engineering, procurement and construction companies.  

CRISIL expects an improvement in recoveries of bad loans for banks. The economic revival, policy initiatives in stressed sectors, and effective implementation of the Bankruptcy Code can potentially accelerate recoveries.

However, gross non-performing asset ratio of the banking sector is expected to touch 10.8 per cent in FY18 versus 9.5 per cent estimated for FY17 and 7.5 per cent in FY16.

Microfinance institutions (MFIs), whose collections were hit by demonetisation, are seeing a build-up in stress. “If the recent trend of defaults continues, there would be asset quality pressures for MFIs,” said Pawan Agrawal, chief analytical officer-ratings, CRISIL.  

CRISIL highlighted the uncertainties of the protectionist undercurrent in the US, elections in Germany and France, and Brexit. These political risks, if they materialise, could quickly morph into economic risk, it said.