Ind-Ra: Bottoming Out of India Inc's Credit Metrics Coincides with Historic High Vulnerability

India Ratings & Research (Ind-Ra) says that a number of financial indicators are suggesting a bottoming out of the credit profile of BSE 500 corporates. For instance, FY14 was the first year since FY11 when the corporates' (excluding banking and financial services) yoy growth rate of aggregated EBITDA (14.1%) and funds from operation (FFO; 18.4%) exceeded the growth rate of balance sheet debt (13.8%) and interest expense (10.2%). As such, the number of sectors (nine) showing directional deterioration in operating performance as well as credit metrics is lower than in 2013 (12).

In line with Ind-Ra's expectation, certain sectors have shown tentative signs of turning around since 2HFY13, driven by a directional-though-muted improvement in domestic and global demand coupled with a stable domestic currency. These sectors are shipping, retail, chemicals, pharmaceutical, telecommunication services and media & entertainment. These are also the sectors where Ind-Ra upgraded the sectoral outlook at the start of 2014.

While a bottoming out is generally considered a precursor of recovery, the agency remains cautious as the signs of a broad-based recovery are yet to be reflected in the financial statement of BSE 500 corporates. Ind-Ra believes corporate vulnerability, expressed as the number of corporates with FFO interest coverage ratio below 1.0x, is at the highest level since FY09. In FY14, one out of five corporates was highly vulnerable to any economic shock. Thus, any recovery of the majority of corporates would be conditional on a stable interest rate, a stable domestic currency and a gradually improvement in economic conditions. Any adverse change with respect to one or more of these assumptions may significantly increase the level of financial stress.

The lack of robust demand in the economy as well as possible limited access to credit/liquidity continues to affect the working capital cycle of BSE 500 corporates. The working capital cycle remained stretched in FY14 and was at the same level as in FY13. Although cash flow from operations margins have shown a marginal improvement, cash flow from operation continues to languish at multiyear lows. The recent stabilisation of operating margins may not be sustained for a significant period if the working capital cycle and cash generation ability of corporates do not improve meaningfully.

Sectors such an infrastructure & construction and metals & mining may remain stressed in FY15. Only substantial improvements at the operational level would cause a meaningful improvement in their credit profile, given the high leverage levels and negligible cash generation ability of corporates in these sectors. The high leverage levels may constrain the ability of some corporates to access credit. This could prevent some of these corporates to tap growth opportunities that a domestic economic revival may present. These sectors may require significant equity capital infusions or large-scale asset sales to pursue growth.

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