After registering several index highs, India Inc bears the weight of high expectations. From margin expansion to multiple expansion, the benchmark index at current levels is baking in a near blue-sky scenario. While revenue and earnings growth potential are repeatedly scrutinised, what flies under the radar is the balance sheet strength that is needed to support this growth. 

We analysed 1,696 companies with reported financials from FY19 to H1FY24 to answer three main questions. What is the pace at which fixed assets have been added by sectors/companies? What is the debt liability onboarded to finance them? And finally, what is the shareholder return implication from the activity?

Our analysis shows that India Inc’s balance sheet today is healthy for a fresh round of capex to fuel the next leg of growth. Pace of asset addition matches pace of revenue growth. Leverage has been constant or better in some cases. Return ratio is currently at a multi-year high.

But investors must note that while capacity of the balance sheet to support growth is strong, actual growth will continue to be a function of demand.

Absolute fixed assets addition

If the given set of companies reported 8 per cent revenue CAGR during FY19-H1FY24, fixed assets growth at 6.9 per cent in the period can be seen as keeping pace with it. While additions in FY21 did falter due to Covid, the later periods made up for the lag (see table); especially the 12 per cent addition witnessed in FY23. The first half of the current fiscal has seen a slowdown on overall basis though some sectors continue to show good growth.

This overall slowdown could be attributed to a ‘wait and watch’ approach in some pockets after a high base. It could also be that capex is back-loaded in the second half. Sectorally, refineries (essentially Reliance Industries), oil and gas and chemicals have seen high growth over the last five years. Except for oil and gas, investments may slow down in the other two for reasons explained below.

Reliance Industries reported 15 per cent fixed asset addition in the last five-and-a-half years. Especially post-Covid, the company added assets at 20 and 27 per cent YoY in FY22 and FY23 but has slowed to 5 per cent in H1FY24 as its ventures attain self-sufficiency.

ONGC is the main driver in oil and gas sector. From average 7-8 per cent addition, the company reported a spectacular 60 per cent asset growth in H1FY24 alone. The oil major plans a renewable foray and has chalked out plans of ₹1,00,000 crore by FY30 for foraying into solar space.

Within chemicals, SRF, which is the industry leader, added assets at the rate of 18 per cent in the last five-and-a-half years, similar to peers. Either import substitution or China +1 has evidently driven capex additions. In the short term, though, with a resurgence in China’s output or weak demand following high inventory build-up in Europe, speciality chemicals may most likely temper expansion plans — after nearly a decade of sharp expansion.

In sectors including steel and automobiles, where stock returns have far exceeded index returns due to a cyclical upturn, fixed asset additions have surprisingly been underwhelming. Industry leader Tata Steel towed the average at 5 per cent CAGR in the period as European operations have been stagnant at best (the Netherlands) or under restructuring in the UK. JSW Steel led from the front, adding capacity at 14 per cent CAGR. Interestingly, amongst the smaller caps, Shyam Metalics, APL Apollo Tubes and Welspun have added fixed assets at 27-31 per cent CAGR in FY19-H1FY24.

Despite pent-up order book, improved product mix and realisations, automobile capacity addition at 1 per cent CAGR in the period misses the mark. Capex is not a major part of the Auto story as yet, with split between internal combustion and Electric vehicles vying for the moderate allocation.

Improved leverage metrics

For India Inc, the positive takeaway is that this has not been a debt-fuelled expansion — unlike earlier periods. Leverage ratio for India Inc stands at a more acceptable 2.5 times net debt to EBITDA in H1FY24, contracting significantly from 4.2 times in FY19. In relation to fixed asset growth, pace of debt expansion at 5.4 per cent CAGR for FY19-H1FY24 is a step below asset addition growth mentioned earlier.

Sectors that saw sharpest fixed asset expansion, refineries (13 per cent) and oil & gas (21 per cent), have witnessed only 3 and 6 per cent CAGR growth in debt in FY19-H1FY24.

For pharma, steel and cement, where fixed assets have grown by 3-5 per cent CAGR, debt has actually gone down in absolute basis, declining at -4 to -2 per cent CAGR FY19-H1FY24. Commodity cycle is a part of the reason for decline, albeit in different ways. Steel and cement gained from higher prices and volumes in the last five years, which helped with deleveraging.

With reversal expected in commodity price inflation (derived from slower global growth forecasts) price-driven growth may falter even as domestic volume growth may be strong. Pharma, on the other hand, has seen a reversal of fortunes in the US market along with several high-value launches. But domestic market growth faces increasing headwinds from intense competition.

The two sectors at high leverage are power distribution (4 per cent CAGR FA growth Vs 3 per cent CAGR Debt addition in FY19-H1FY24) and telecom (3 per cent CAGR FA growth Vs 12 per cent CAGR Debt addition). Despite improvement in net debt to EBITDA in all segments, the ratio continues to be above three times for these two.

Power sector will remain over-leveraged owing to several factors. Power deficit in India can keep realisations elevated, allowing for effective debt servicing. Ministry of Power’s ambitious 500 GW addition by 2030-32 should keep demand for capital elevated. PSUs mostly operating in the sector with government backing adds credibility to credit demand and servicing capacity.

Leverage in telecom derives from Vodafone and Bharti Airtel, both of which have divergent outlooks. Moratorium on spectrum-related dues is keeping Vodafone afloat, which needs further capital infusion to compete. Bharti Airtel’s capex phase may be nearing an end with 5G investments and structural uptrend in ARPUs from a consolidated industry may deleverage Bharti Airtel’s balance sheet.

Shareholder returns on top

At 15.6 per cent RoE (Return on Equity) for India Inc in H1FY24 (based on annualised PAT), which is a 390 bps improvement over FY19, shareholder returns have been strong. On looking at the return drivers between revenue and PAT growth of 8.7/17.5 per cent CAGR in FY19-H1FY24, one can find that margin expansion has been the real value driver for shareholders. EBITDA margins for the lot increased from 14 per cent to 20 per cent in the period. With the exception of steel, all the other sectors witnessed expanded margins. Power, automobiles and telecom had a double-digit margin expansion in percentage points.

Amongst sectors, RoEs shrunk for steel and chemicals and RoE has been flat for cement. Moderation in returns further underlines the expected slowdown in chemicals’ asset growth and underwhelming asset growth in steel mentioned earlier. But being tied to the commodity cycle, these three sectors (steel, chemicals and cement) are bogged down by the slowdown in commodity inflation, which indicates a burnout of growth.

Overall, India Inc sitting on healthy return for shareholders while increasing asset base of operations is a positive sign. That the leverage ratios are at near-ideal levels further supports the current ongoing rally in indices. But as commodity inflation turns decisively negative, chemicals, steel and cements may lose their sheen. Power, auto and telecom show strong appetite for continued growth.

Capex streak continues

Going forward, companies are sticking to capex plans made earlier without any marked change in stance. Leading from the front is power sector capex — with ambitious 500 GW of additional power capacity to be installed by 2030-32 of which a significant portion is under works. NTPC, Adani Green, Tata Power and JSW Energy will sustain their capex momentum. The power transmission infrastructure is also pushing capex plans, with Power Grid expected to undertake a significant chunk of the planned ₹2.4-lakh crore inter-State transmission capex by 2030.

PSUs as a group are similar to broader market in terms of capacity addition or lower reliance on debt. However, on outlook, SAIL, NTPC, ONGC and other PSUs do have big capex plans. NTPC is looking to spend ₹25,000 crore on capex over the next three years to support its plans to create 130 GW power generation capacity. ONGC plans to foray into renewable energy at an even higher outlay (₹30,000 crore for FY24).

Reliance and Bharti Airtel should be nearing 5G capex completion in FY24-25 and later focus on deleveraging. Reliance’s retail arm, with a strong ₹24,000 crore operating cash flow expected in FY24 on its own, should support its growth requirements, moderating Reliance’s capex phase.

Steel companies Tata Steel, JSW Steel, or SAIL are looking to double their capacity in the next ten years with ₹10,000–12,000 crore capex apiece every year even as RoE moderation, margin compressions or import competition do not support the expansion.

Similarly, the chemicals sector is unrelenting on expansion, despite financials not being in support. But, company-specific case can be made when expansion is for contracted capacity or a product-specific expansion.

Finally, cement and paints, part of the construction bracket, are steadfast on expansion. Grasim’s paints foray and Asian Paints expansion will intensify competition in paints. Cement, on the other hand, is equally focused on consolidation and greenfield expansion at the same time.