India Inc's Balance Sheet Is Deleveraging...

Thu, 30 Jun Pre-Open

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Over the past few years, India Inc. has been grappling with rising debt. In order to reduce this debt, companies have resorted to asset sales. Some companies have sold their non-core assets and restructured to help them repay debt on their books. The Reserve Bank of India (RBI) in its bi-annual Financial Stability Report (FSR) provided data on the performance of the corporate sector. Overall, the performance has improved with a fall in the number of leveraged companies as well as the amount of debt these companies were servicing. India's financial system remains stable, although the banking sector is facing significant challenges.

The RBI's sample size was around 1,800 and 2,600 non-government and non-financial listed companies respectively. The number of companies which had a debt to equity of 2x or greater dropped to 14% of the RBI sample size from 19% in March last year. Importantly the debt of these companies dropped to 20.6% of the total corporate debt compared with 33.8% earlier. Both sales and profitability of these firms improved over the year. The survey found the percentage of weak companies that were leveraged to be higher for electricity, construction, iron and steel, real estate and textile sectors.

The leveraged weak companies with lower debt servicing capacity and high leverage will exert further pressure on an already deteriorated asset quality of banks. The banking sector continues to get impacted by lower credit growth with stressed loans being the major reasons for the same. Infrastructure, metals and textile sector have contributed most to stressed loans in the banking sector, while retail sector continues to be least stressed. While the share of gross NPAs has seen a sharp rise over the past year, this has been due to the asset quality review which was undertaken by the RBI. Public sector banks have 14.5% of stressed loans on their total loan book, while that of private and foreign banks was 4.5%. A matter of concern is the data for textile industry, as the industry had the highest number of standard accounts slipping into NPA category. This was followed by the cement industry.

Corporate loan growth has slowed down. Plus, the banking sector has a lot on its plate firefighting bad loans and conducting balance sheet repairs. Thus, there is an increased need for non-banking financial companies to help provide easy access to credit and financing for economically viable projects.

For a recovery, the key data points to watch out for would be the capacity utilization levels. An increase in the utilization levels would help improve the currently depressed profit margins and provide a fillip to earnings. This in turn would ease the debt burden of already leveraged companies and help improve their balance sheets further. Improving financial position of these companies are positive signs of a slow and gradual recovery.

Indeed, we recently explained how capacity utilisation levels could impact the 70% upside in Sensex earnings. Here is what we wrote...

• Healthy levels of capacity utilisation are, however, necessary to make the Sensex upside a reality. Therefore, the most important data point that I will be tracking is the capacity utilisation of companies that have recently added capacity. We will be wary of businesses in sectors that are more likely to face overcapacity in the next few years.

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