 "Ambit Capital has got it wrong")
Ambit Capital Research has got it wrong. Private corporate sector has pulled plug on capital expenditure not because they want to engineer a slowdown but their balance sheet doesn’t permit them to invest in big ticket-projects anymore. The recent rhetoric about growth revival and a rally on Dalal Street India Inc notwithstanding, India Inc balance sheet is in a bad shape giving them little elbow room take up fresh commitments.
At the end of March 2014, latest year for which full corporate balance sheets are available, BSE 500 companies, excluding bank and financials, were sitting on a total debt of around Rs 23 lakh crore or around $350 billion. It has translated into gross debt-to-equity ratio of 1.3, up from 0.9, at the end of financial year 2008-09. On net basis (excluding cash and equivalents from company’s debt) leverage ratio rose to 1.0 at the end of FY14 from 0.6 at the end of FY08.
And the companies, which have financial muscle to invest, are facing excess capacity and falling demand for their goods and services. They have the option to grow through M&A, which is what many large firms in cement, power, port and steel are doing.
And the companies, which have financial muscle to invest, are facing excess capacity and falling demand for their goods and services. They have the option to grow through M&A, which is what many large firms in cement, power, port and steel are doing.
In the past five years ending March 2014, corporate debt grew at a compounded annual rate (CAGR) of 21.4% and the combined debt nearly tripled during the period as companies bet on large-ticket projects at home and many went for multi-billion dollar overseas acquisitions in a bid to acquire global scale.
Obviously, promoters and companies were taking a big gamble on growth and believed that future growth in revenues and earnings will take care of the excess borrowings. The 2008 global financial crisis and the resulting growth slowdown, rupee depreciation and increase in interest rates however made many projects financially unviable, landing companies in a financial soup.
Revenue and profit growth however didn’t keep pace with the surge in corporate liabilities. The combined revenues for the sample grew at a CAGR of 13.2% while operating and net profit grew at the pace of 15.3% and 9.8% respectively during the period. The mismatch greatly reduced companyies' debt servicing capability, landing many highly leveraged firms in a financial mess.
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The above-mentioned averages, however, hide the extent of financial pain in capital hungry sectors such as infrastructure, power and metals where Ambit said, it found evidence of a “created” slowdown and quoted sources close to the Prime Minister.
Take construction and infrastructure sector, for example. It was the fastest growing industry under the two terms of the United Progressive Alliance (UPA) government. In the past five years ending March 2014, infrastructure companies grew their capex at a CAGR of 32%, double the pace of growth in the entire sample (16.8%). Nearly fourth-fifth (81.6%) of the incremental capex was, however, financed through borrowings. As a result industry’s leverage ratio swelled to 3x at the end of FY14 from 1.5x at the end of FY09.
Their revenues and operating profit during the period grew slower at CAGR of 16.7% and 20.3% respectively. Most of the incremental growth in gross earnings was, however, soaked up by interest expenses and depreciation allowances resulting in a flat growth in net profits. Given this infra companies are hardly in a situation to grow capex unless these companies take more debt.
It's similar in power sector. Industry’s capex (gross block) jumped 2.7 times in the last five years growing at CAGR 22% between FY09 and FY14 largely funded through debt. Incremental borrowings accounted for 77.2% of the industry’s incremental investment during the period as power companies bet on mega projects such as 4,000 MW Ultra-mega power projects. At the end of FY14, power companies in our sample had a debt-to-equity ratio of 1.9 up from 0.88 at the end of FY08.
Metals and mining companies on the other hand, were let down by a global meltdown in demand and metal prices post-2008 financial crisis. This landed many metal producers in financial difficulties despite a relatively moderate growth in capex and debt in the past five years. Between FY09 and FY14, the industry’s investment grew at a CAGR of 18%, in line with the macro growth, but a single digit growth in revenues and profits made even this modest growth unsustainable and future outlook even more grim.
Of course there are some exceptions to this macro trends. Many of the top companies in sectors such as cement, automobile, consumer goods, pharmaceuticals, capital goods and oil & gas are financially well placed with little or no leverage and healthy cash flows. But even here, companies are facing demand slowdown and poor capacity utilisation providing little incentive for fresh investment.
Cement companies for example used only 66% of their production capacity in FY15 down from 82% in FY09. At the end of FY15, industry’s had an installed capacity of 390 million tonnes against production of 256 million tonnes. Cement demand grew by just 3% in last two years, which is the lowest in a decade.
This only leaves the possibility of inorganic growth for bigger and financially stronger players. And this is what Aditya Birla group’s Ultratech Cement and Bangur’s Shree Cement are doing. Both the companies have acquired cement assets from Jaiprakash Associates as it sells off assets to lower its high-debt burden.
A similar play it at work in power, port and steel sectors where stronger players such as JSW Energy, Adani Port, Adani Power and JSW Steel have acquired assets from their financially struggling peers.
While quoting sources close to the PM, Ambit should have looked at the demand destruction caused by a sharp cut in government spending in last two years. Consumer demand especially in the rural India was a big growth driver for corporates in the last fives but the golden goose has been killed for all practical purposes for now. Fiscal austerity started in the last years of UPA-II, but the current government has turned it into a religious zeal and the last budget witnessed a high double digit government spending on education, health, rural development and subsidies among others. This coupled with a token increase in minimum support price for foodgrains has worsened rural distress destroying demand for consumer goods.
I can’t visualise a faster growth when nearly 60% of the population faces income squeeze. A forced capex in such an environment will only lead to more financial problems for corporates and burden banks with more bad loans in future.