Manufacturing activity is likely to pick-up somewhat, however service sector corporates will continue outperforming corporates in the manufacturing space. The benefits of lower commodity prices for some sectors are likely to fade away in FY17; however lower interest costs could support corporate profitability on a broader basis. Given the stability in working capital, currency risk could be the biggest challenge for Indian corporates in FY17.
Demand Conditions to Improve Modestly: For 9MFY16, private final consumption expenditure at current prices grew 11.2% yoy (FY15: 10.5%, FY14: 10.8%) driven by a pick-up in urban consumption owing to lower inflation. However, rural consumption remained weak as a result of a weak monsoon. While the government's budget for FY17 is focused on fiscal consolidation, it is also concentrated on rural development which will probably lead to an improvement in rural demand. This is likely to aid corporate earnings growth in FY17. However, the extent of improvement will be limited as capex activity remains muted. Additionally, goods and services exports which account for around one-fourth of the GDP are also likely to remain subdued.
Commodity Price Benefits to Fade: Though falling commodity prices have impacted commodity sellers, the commodity price correction has provided some benefit to commodity users in industries such as textiles, chemicals, power, auto and airlines. Nonetheless, the broader impact of lower commodity prices has been deflationary. The aggregate revenue of the sample set of manufacturing firms (excluding oil & gas companies) analysed by Ind-Ra grew by a meagre 0.3% in 1HFY16 (FY15: 5.7%, FY14: 7.1%) and correspondingly, the aggregate EBITDA by 2.9% (0.6%, 5.2%). The agency expects the benefit of lower commodity prices to fade away during FY17 for corporates which have benefitted, on commodity prices remaining range bound.
Service sector corporates will continue to perform better than manufacturing companies. However, their growth levels are likely to remain range-bound in the mid to high single digits. The aggregate revenue of the sample set of service sector companies analysed by Ind-Ra grew by 6.8% in 1HFY16 (FY15: 3.3%, FY14: 12.6%) and correspondingly, the aggregate EBITDA of these firms grew by 10.7% (4.8%, 20.8%).
Interest Costs to Provide a Breather: At FYE15, about 25% (INR8.1trn) of the total debt (INR31.3trn) of the largest 500 listed corporate borrowers was with entities with an interest coverage (EBITDA/gross interest expenses) below 1x and another 15% (INR4.8trn) with companies having an interest cover in the range of 1x-1.75x. Ind-Ra expects the interest coverage of these entities to bottom out in FY16 and to show a marginal improvement in FY17 on a reduction in interest rates. Particularly, lower interest rates would benefit vulnerable entities which have an interest cover between 1x and 1.75x. However, around one-third of debt of the largest 500 listed borrowers remains with corporates having stressed credit profiles and this situation is unlikely to change in FY17.
Working Capital to Remain Stable: The net cash conversion cycle for Indian corporates has been stable over the last couple of years. Average net cash conversion cycle days for the largest 500 borrowers (excluding outliers) have been in the range of 75-78 while the median working capital cycle has remained around 66-68 days. As the demand scenario is unlikely to deteriorate in FY17, the agency expects the working capital situation to broadly remain stable.
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Sensitivity to Rupee Depreciation: Nearly half of the top 500 listed corporate borrowers have a negative sensitivity to rupee depreciation, and about half of the debt belongs to corporates who are net foreign currency spenders. A slowdown in emerging markets has increased the risk aversion towards emerging market assets and has led to continued volatility in currency markets. External shocks translating into bouts of risk aversion which usually causes rupee depreciation and particularly, increased volatility may impact the fragile recovery in FY17. Corporates dependent on imports and foreign currency borrowings are likely to be affected by the continued volatility in the currency market.
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