Corporate India gradually reverts to normalcy from Q2 FY2021; current quarter to be supported by seasonal festivities: ICRA

• After the unprecedented sharp degree of contraction in Q1 FY2021 due to the lockdown, India Inc. has been gradually reverting back to normalcy as the lockdown-related restrictions eased; the pace of Y-o-Y revenue contraction reduced to 6.5% from 32.6% in the first quarter
• Furthermore, cost-control initiatives undertaken by Corporate India during the peak of the lockdown coupled with revenue recovery supported healthy margin recovery; accordingly, PBT margins expanded on Y-o-Y as well as a sequential basis to 9.1% during the quarter
• The sustainability of recovery post the ongoing festive season remains critical in determining the overall macro-economic growth trajectory

The Indian Corporate sector has been gradually reverting back to normalcy after experiencing major Covid-19 pandemic induced disruptions and the resultant two-month-long nation-wide lockdown. The restrictions imposed to combat the pandemic in Q1 FY2021 resulted in an unprecedented 33% revenue contraction.  As the lockdown-related restrictions eased and the economy opened up, the macroeconomic activity is showing signs of a revival, though at a gradual pace. Accordingly, an ICRA analysis of financial results of 587 companies in the Indian Corporate Sector (excluding financial sector entities) showed aggregate revenues growing by 34.9% in Q2 FY2021, from Q1 FY2021 levels although it remained lower by 6.5% on a Y-o-Y basis. The margins to have registered an improvement during the second quarter.

Exhibit: Trend in aggregate revenue growth of sample of 587 companies

Commenting further, Mr. Shamsher Dewan, Vice President – Corporate Sector Ratings, ICRA said, “During Q2 FY2021, sequential recovery from Q1 FY2021 levels was visible across sectors as the restrictions eased, and some sectors were even able to bounce back to pre-Covid levels and report revenue growth on a Y-o-Y basis. Among consumer-oriented sectors, although large-ticket discretionary purchases like leisure travel and lifestyle retail continue to remain on the back-burner due to risk aversion and general uncertainty, the demand in several other sectors, including passenger vehicles, two-wheelers, consumer durables, etc. have bounced back over the past few months. Essential goods like FMCG and consumer foods were not impacted materially even in the midst of the lockdown, given their essential nature and continue to remain so.”

Among other sectors, commodity-oriented sectors such as cement, iron & steel, and metals & mining sectors also reported sequential and Y-o-Y recovery, supported by firming up of commodity prices as well as volume expansion; and aided by a pick-up in industrial activity. Industrial and Infrastructure-oriented sectors, on the other hand, while exhibiting sequential recovery, are yet to reach their year-ago levels, and contracted by 11% and 14% on a Y-o-Y basis respectively during the quarter. Select sectors such as IT, reported muted revenue growth of 4% in INR terms, although organic growth was impacted by a deceleration in key verticals. Sectors like pharmaceuticals, power, and telecom also recorded Y-o-Y revenue growth.

On the profitability front, India Inc. delivered a positive performance, with both operating profit and PBT margins at multi-quarter highs. Many entities aggressively rationalized costs through salary cuts, downsizing of the workforce, renegotiation of rentals and interest rates, curtailment of overheads such as travel and conveyance, etc. from the first quarter itself in order to survive the challenging period. The benefits of these percolated into the second quarter, which coupled with a sequential recovery in revenues, aided the significant recovery in margins. Accordingly, PBT margins expanded on Y-o-Y as well as a sequential basis to 9.1% during the quarter. However, ICRA does not expect these margin levels to sustain, given the raw material headwinds due to the firming up of commodity prices, and the gradual reversion of costs to pre-pandemic levels.

Exhibit: Trend in aggregate PBT margin for sample of 587 companies

The interest coverage ratio of ICRA’s sample, adjusted for sectors with relatively low debt levels (IT, FMCG, and Pharma) witnessed a Y-o-Y and sequential improvement to 3.4x in Q2 FY2021 from 2.0x in Q1 FY2021 and 3.4x in Q2 FY2020. With the country coming out of the lockdown, the pressure on earnings abated, which supported the credit metrics significantly. Additionally, interest costs also decreased by 4% on a Y-o-Y basis as companies cut down on their CAPEX and working capital requirements while negotiating lower interest rates. However, the interest cover weakened in some stressed sectors like construction, real estate, and textiles. In select sectors like telecom, textile, and real estate, it was precarious at close to 1.0x, implying difficulty in meeting even interest obligations. During this period, the moratorium allowed by the RBI till August 31, 2020, would have provided much relief.

Exhibit: Trend in interest coverage ratio for sample of 587 companies

The sequential recovery in performance was visible across many of the key sectors in Q2 FY2021 and has improved further during the current quarter so far. While easing off of lockdown-related restrictions supported this sequential recovery to a large extent, with some pent-up demand also visible, the other supportive factor has been the rural positivity. Rural sentiment had been positive after two healthy crop cycles of Kharif and rabi in 2019, and indications of another bumper crop of Kharif 2020 augur well for maintaining this positivity. Accordingly, select sectors like tractors, two-wheelers, etc. have witnessed faster recovery vis-à-vis other sectors.

Other indicators like freight activity, electricity, and fuel consumption also indicate a healthy recovery to pre-pandemic levels by the end of Q2 FY2021 and as we progressed further into Q3 FY2021. Data on movement of goods on National Highways, as indicated by the Fastag and E-way bill volumes, recovered to pre-pandemic levels in September 2020, and is further improving, which was also visible in the railway freight data. Similarly, electricity demand recovered to pre-lockdown levels and is currently 4% higher on a Y-o-Y basis. Additionally, data on monthly diesel and petrol consumption suggests that fuel consumption in October 2020 has been higher than the FY2020 average despite firm prices.

However, some sectors like aviation and hotels continue to face challenges, which are expected to persist over a prolonged period. Daily airline passenger traffic, while improving sequentially over the months, still continues to remain at around half of pre-covid levels, given continued restriction (especially on international travel) and risk aversion towards travel, albeit improving. Similarly, the hotel sector also continues to grapple with historic-low occupancy levels, despite some quarantine-related and healthcare staff traffic diverted to hotels. Accordingly, recovery in these sectors is likely to be a longer-term phenomenon, given the discretionary nature of spend, and customer wariness that is likely to continue till a vaccine is made available commercially.

In terms of investment-related sectors like construction, the pace of recovery remains to be seen, given fiscal constraints, especially of state governments, due to allocation of funds towards pandemic-relief measures. However, healthy project awards during the second quarter, especially by NHAI and MoRTH are encouraging, though pickup in execution also remains critical.

“On the demand side, ICRA expects that India Inc. would gradually revert to normalcy and would be able to sustain improvements in Q3 FY2021, given the seasonally strong festive season. Rural demand continues to be on a positive trend, supported by the normal monsoon, healthy crop outputs, and Government support in the form of increased MNREGA allocations, MSME guarantee loans, etc. Accordingly, the recovery is expected to continue to be rural-led, while urban India would gradually catch up. Nevertheless, the sustainability of the recovery, post the ongoing festive season, would remain critical in determining the overall macroeconomic recovery trajectory. Additionally, the occurrence of a second or third wave of a pandemic can reverse the recovery reported so far, in the absence of the availability of a vaccine,” concluded Mr. Dewan.