SMEs have been the first casualty of the current cyclical downturn. The revenue growth (median) of small companies has fallen from FY10 and has been in low single digits since FY11. However, revenue growth for large companies (represented in BSE 500) and medium companies has tapered off only FY13 onwards. The agency is of the view that SMEs' median revenue is unlikely to improve in the next 12-18 months.
Small companies typically have lower bargaining power than BSE 500 corporates' with the former's EBITDA margin being 8-10 percentage points (pp) lower than the latter's in comparable industry categories.
Working capital cycle (median) sharply deteriorated for SMEs to 104 days in FY12 from 85-87 days in FY11. This to an extent explains their pitiable below 1.0% cash flow from operations margin since then. Further working capital cycle deterioration may virtually wipe out a large number of SMEs. Thus, large corporates (as represented in BSE 500) were forced to take a hit in their working capital post FY11 as SMEs were in no position to be squeezed further.
Ind-Ra believes that unless the working capital days of large corporates come down significantly to below 50, the working capital cycle of SMEs is unlikely to improve. It would require the economic activity to reach the level last observed in FY11-FY12. This is unlikely to happen in the next 12 to 18 months.
So far in 2014, the median revenue of SMEs has declined 1% yoy and 7.8% yoy, respectively, and deterioration in EBITDA margins and fund flow from operations (FFO) margins has continued unchecked. FFO coverage for 25.7% and 26.1% of medium and small corporates, respectively, was below 1x in 9MFY14.
SMEs' portfolio majorly includes companies from chemical, textiles, power, real estate, steel and construction sectors. Ind-Ra has a negative outlook for all these sectors, except a stable outlook for real estate. Sectors, already under stress, have the highest number of SME corporates with potential issues in servicing even the interest component. The construction sector has the highest number of SMEs (36.5%) with coverage below 1.0x, followed by real estate (33.8%), power (30.6%), textiles (28.5%) and chemicals (20.5%).
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