In contrast to expectations, the financial performance of Indian corporate sector failed to improve meaningfully in the recently concluded fiscal year FY 2015. While whole host of factors were at play, the impact of relatively muted pick-up in consumption demand, continued challenges on the execution front in the infrastructure space, severe cut back in Government spending along with an absence of meaningful recovery in capex cycle had the most pronounced impact. The fiscal 2015 was also characterized by slowing rural economy as factors including weak monsoon followed by untimely rains, lower than expected agriculture output and modest increase in minimum support prices (MSP) for key crops impacted incomes of rural households.
The year 2015 was also marked by sharp correction in global commodity prices, especially for crude oil, whose prices have corrected by almost 42% since July 2014 before touching a low of US$ 45/barrel in January 2015. Although lower crude oil prices are a positive for oil marketing in India as it helps in bringing down their subsidy burden, the sudden fall led to inventory losses (for refineries and oil marketing companies) and lower realizations (for oil marketing companies) during the second-half of the fiscal. Consequently, most of the oil producing companies (including ONGC, Cairn India etc) and refineries like MRPL etc. reported sharp drop in their earnings during the year. That apart, softening demand for steel globally also impacted the prospects of the domestic steel companies as decline in steel prices in the international market exerted pressure on realizations of Indian steel producers, particularly from H2 FY 2015 onwards. The sector, which was already facing the burden of rising operating costs due to shortage of domestically mined iron ore and firm coal prices, as well as very muted demand growth, now had to face stiff competition from cheaper imports. With concerns on slowdown in China rising, the possibility of further correction in commodity prices has increased.
While operating environment in many of the core industries remained challenging, some of the domestic-oriented sectors like automobiles; cement (however slowed down in H2 FY 2015) and consumer durables did see uptick in demand. For instance, despite rural slowdown, the automobile production (in volume terms) in India grew by 8.7% during FY 2015 compared to 4.0% in FY 2014. The improvement was particularly driven by recovery in Medium & Heavy Duty Truck segment (replacement of ageing fleet) and Passenger Vehicles (improving consumer confidence and cost of ownership, in the backdrop of lower fuel prices).
Apart from automobiles, some of the other sectors that witnessed improvement in operating metrics included – Telecom, FMCG, Auto Components, Tyres and Cement. While improved operating performance of telecom companies reflected the industry-wide trend towards better pricing power and strong growth in under-penetrated data services segment, industries like Auto Components benefited from pick-up in domestic demand, favorable exports scenario and softening commodity prices.
Weak earnings growth continued to defer improvement in credit metrics in FY 2015
During 2015, while many of large corporate groups did initiate efforts to improve their balance sheets by hiving-off non-core assets, raising equity as well as limiting capex plans, the overall impact on credit metrics on debt heavy entities was fairly muted – also earnings didn’t improve meaningfully to reduce stress. Accordingly, credit ratios like TD/EBITDA for sectors like Power, Construction and Iron & Steel remained in the range of 4.8x-15.0x during FY 2015 while Interest Coverage ratio also didn’t show signs of improvement.
We expect this trend to continue in the near-term as many of the core sectors continue to face structural issues. For instance, power sector, which accounts for majority (21%) of the debt in our sample faces challenges in form inadequate feedstock availability (especially natural gas), weak financial profile of state power distribution companies and uncertainty related to timeline for implementation of tariff compensation for affected IPPs. Similarly, most of the key entities in Steel sector continue to have high leverage, which is unlikely to reduce as weakening steel prices would continue to exert pressure on earnings. The credit ratios improved for Automobile OEMs and Tyres, supported by improving demand and favorable commodity prices. In addition, some of the less capital intensive sectors like IT, FMCG, and Pharmaceuticals also continued to either improve or maintain their strong credit metrics.
Aggregate margins remained stable but more industries witnessed contraction sequentially
From profitability perspective, the aggregate EBITDA margins of 515 companies in our sample remained relatively stable during FY 2015. However, entities in sectors like Metals, Capital Goods, Refineries and Oil (Upstream) continued to witness pressure on margins on account of industry specific issues. Additionally, the trend in EBITDA margins on a sequential basis also showed some signs of weakness with number of sectors that witnessed margins contraction increasing from just one (in Q2 FY2015) to six (in Q3 FY 2015) and eight (in Q4 FY 2015). This trend largely correlates with the trend of macro-economic indicators, which also reflected relatively weak pace of improvement in H2 FY 2015 vis-à-vis H1 FY 2015. While consumption trends remained subdued, companies in sectors like FMCG, Consumer durables, Auto Components etc. reported improved margins, benefitting from lower commodity prices.
Net earnings impacted by industry-specific issues and one-time impairment charges
In FY 2015, net earnings of 515 companies (in our sample) declined by 12% to Rs. 2,707 billion with entities in the Oil & Gas space, Iron & Steel, Construction and Telecom being the key contributor. Apart from industry specific issues, the decline in net earnings of entities in some of the key sectors, especially Iron & Steel and Capital Goods was also accentuated by one-time impairment/write-off on certain investments. Apart from Iron & Steel and Capital Goods, some of the other sectors that incurred losses (at an aggregate level1) during FY 2015 were – Airlines, Construction/Infrastructure, Sugar, Hotels and IT-Hardware. However, unlike Iron & Steel and Capital Goods (where aggregate losses were influenced by select entities), the proportion of multiple entities incurring losses was higher.
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