Economy

U-shaped recovery see in interest cover ratio across key sectors: CARE

Our Bureau Mumbai | Updated on December 25, 2020

Says ratio will improve if cost savings invoked in Q2 are retained in subsequent quarters

The interest cover ratio (profit before depreciation, interest, and tax to interest cost) for a sample of 3,452 companies across all sectors, excluding banks and non-banking finance companies (NBFCs), has followed an expected U-shaped pattern — declining for two quarters before recovering in September 2020 — according to CARE Ratings.

In September 2020, this ratio stood at 5.3, against 2.7 in June 2020, 2.6 in March 2020 and 4.7 in December 2019.

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The credit rating agency said interest cover and its trend are a good indicator of the present as well as future debt servicing capability. As it is a ratio of profits to interest costs, it indicates the ability of the firm or industry to service this part of debt.

Useful signal

“A falling ratio raises the flag of possible pressure and hence becomes a useful signal to lenders. It would also be a good gauge of the NPA (non-performing asset) build-up and is hence also a quick indicator of the same,” the agency said in a note.

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Per the agency’s analysis, December 2019 was a good quarter for the industry as it was pre-pandemic, and activity was mostly normal. “The March 2020 quarter saw the first signs of stress as the lockdown came in the way of ramping up of sales in the last week, which affected the overall performance. Some of the services had already been buffeted by restrictions in February as the fear of the infection affected operations,” the note said.

CARE opined that the June quarter was probably the most challenging as several businesses were non-operational for two months.

“The September 2020 quarter was associated with the unlocking process which began in June and the road to operationalise business opened up, albeit gradually. Companies worked on the costs side to increase profits in an environment where turnover continued to decline in most industries,” the agency said.

CARE observed that for the present year, it would not be possible to link this ratio with the NPA ratios of banks because of the changes in the recognition norms announced by the RBI, which were combined with the six-month loan moratorium.

“But it can be said that given the increase in this ratio for the industry as a whole, the health of the corporate sector appears satisfactory based on the performance in September. To be more definite about this conclusion, the next two quarters would also have to be tracked closely,” the agency said.

Question of sustainability

CARE observed that the crux going forward would be whether or not the September trend of growth in profits can be sustained.

“It may be expected that there would be improvement in topline growth in some sectors such as FMCG, durables and auto. If the cost savings which were invoked in Q2 (July-September) are retained in Q3 (October-December) and Q4 (January-March), there can be further improvement in the interest cover ratios for sectors that have witnessed recovery in Q2. This will also bode well for the banking system, which is trying to get a better grip on the quality of assets issue,” the agency said.

Published on December 25, 2020

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