NEW DELHI : Indian companies’ ability to repay debt is gradually improving despite rising interest rates, aided by cheaper inputs lifting operating performance, significant debt reduction in the recent past, and a fall in working-capital requirements.
A Mint analysis of 382 companies in the BSE 500 index showed that interest coverage ratio (ICR) stood at 7.02 times in the June quarter, better than 6.73 times in the March quarter. The figure, however, is still lower than 7.22 times a year earlier. The analysis excludes banks, insurance and financial services (BFSI) companies.
ICR is derived by dividing a company’s earnings before interest, taxes, depreciation and amortization (Ebitda) by its interest cost.
The primary reason for the better ICR is the continuing decline in the prices of raw material that has improved operating performance. During the quarter, operating profits for the 382 companies rose 8.1% sequentially, compared to a 3.6% rise in their interest costs.
The significant debt reduction over the past few years too has helped, analysts said. Over the last four years, India companies have focused significantly on deleveraging its balance sheet. The focus during the pandemic was on conserving cash and reducing debt, which resulted in a delay in private sector capital expenditure (capex), said Manish Jain, fund manager at Ambit Asset Management.
However, in a rising interest rate scenario, most quality companies have managed to avoid what could have been a crisis, added Jain, who believes that such conservatism shall persist in the near future.
V.K. Vijayakumar, chief investment strategist at Geojit Financial Services shared a similar opinion. “ICR depends on the leverage of companies. When companies borrow more during a rising interest rate cycle, and when the revenues remain sluggish, it impacts ICR,” said Vijayakumar.
He cited the example of a disproportionate rise in Indian companies’ leverage in the post Global Financial Crisis period when the Reserve Bank of India (RBI) had slashed interest rates to revive the economy. He said this raised corporate leverage, depressing profitability and corporate earnings. The market return during 2010-20 was only around 8.5%. “Now we are in a stage of rising rates, but companies have been deleveraging during the last few years. This bodes well for corporate earnings.”
Falling working-capital requirements was another reason for the improvement in ICR, said A.K. Prabhakar, head, research at IDBI Capital.
Supply disruptions during the pandemic and commodity price volatility since 2022 had prompted higher raw material inventories. Supplies have since normalized and commodity prices are subdued, helping lower working-capital requirements.
ICR is improving for small-and mid-cap companies too, indicating their improved financial health. Though mid-cap companies saw ICR at 5.5 times, a slight decline from 5.69 times in the previous quarter, it is much better than 4.44 times a year earlier. Meanwhile, small-caps saw ICR improve marginally on a sequential basis.
Analysts said large-cap companies have better cash positions now compared to mid- and small-caps. Also, the cost of funding as well as requirement for working capital is much higher for smaller companies and therefore, ICR of mid- and small-caps will lag that of larger peers. Further, just one quarter change is not the right way to look at it, but broadly, the improvement in ICR for mid- and small-caps is also significant compared to the September 2022 quarter when ICR had dipped to multi-quarter lows.
“The trend of improvement in operating margins is likely to continue. However, interest rates need to remain stable and the pace of top-line growth also needs to stay strong for ICR to keep improving,” said Deepak Jasani, the head of retail research at HDFC Securities.
Since May 2022, RBI has raised interest rates six times in a row, taking the total hike to 250 bps. The repo rate has moved from 4% to a four-year high of 6.50%. However, any further increase in interest rates or significant capex requirements could temporarily increase interest costs for corporates.
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Updated: 27 Aug 2023, 11:24 PM IST
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