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With US bond yields spiking by 50 bps last month to trade at 10-year highs, markets across the world are coming to terms with yields trading ‘higher for longer’. Irrespective of domestic market resilience, interlinkages in markets can point to a similar situation in domestic interest rates. At this juncture, India Inc’s leverage situation needs monitoring. Domestic balance sheets have improved from FY19 and may not play spoilsport in the immediate short run. But debt ratios have increased in FY23, which combined with an outlook of higher yields, may need regular monitoring.
Finance costs (interest cost per average debt) in FY23 have increased by 110 bps across the top 10 manufacturing sectors (by market cap, see the table) over FY22 and are relatively flat from before the pandemic in FY19. In the fiscal FY23, RBI had increased its repo rate by a whopping 250 basis points. The lower rate of increase in finance costs implies that corporate debt has been shielded from the full extent of the rate hike so far, and if rates stay higher for longer, further revisions may hurt the finance costs and hence, bottom lines. Retail borrowers, on the flipside, have been promptly notified of all rate hikes in the period.
Measured by the interest coverage ratio (EBIT over interest cost) or net debt to EBITDA, the quantum of debt in the top 10 sectors had been slowing untill FY22 but has started increasing in FY23 again. From a low average interest coverage ratio of 5.7 times in FY19 for the top 10, the measure improved to 9.3 in FY22 but has again decreased to 7 times in FY23. Similarly, net debt to EBITDA decreased to 1.84 times by FY22 (2.84 in FY19) and has increased to 1.94 in FY23. Private capex expected to supplement the Central government capex drive, is yet to take off, and leverage is expected to further increase by FY24.
While interest coverage and net debt to EBITDA are relative measures (debt relative to profit and loss), the absolute debt measure also indicates a sharp rise in FY23. Compared to a flat YoY growth of absolute net debt in FY19-22, the debt of the top 10 sectors increased by 13 per cent in FY23 alone.
A decline in operating metrics could partially explain the softening of leverage ratios (interest cover and net debt to EBITDA). Revenue growth in FY23 slowed to 19 per cent YoY from 24 per cent YoY in FY22 for the same set of sectors. And EBITDA margins contracted by 300 bps in FY23 YoY after expanding 200 bps in FY19-22. While the absolute debt levels have increased, a comparatively weaker P&L output also resulted in marginal weakening of debt metrics in FY23.
Amongst sectors, steel followed by cement sectors is to be monitored from a debt perspective. Steel has been positively re-rating in the last three years due to an improvement in debt metrics. But with a sharp fall in steel prices in the last year, a spike in raw material costs, and an aggressive capex drive, the metrics are swaying into a contentious zone again. Steel’s interest coverage and net debt to EBITDA declined from 8.6/0.95 times in FY22 to 3.4/1.9 times in FY23 but are still above FY19 levels of 2.5/2.8 times, respectively. While large capital outlay was supported by a better commodity outlook in steel production, the companies may have to limit leverage to improve on leverage metrics going ahead. Similarly, buoyed by infrastructure capex push, cement companies are in a capex addition phase, while interest coverage/net debt to EBITDA at 4.2/1.2 times in FY23 is weaker than FY22, reported at 6.5/0.6.
Owing to revenue momentum in the automobile sector, the debt metrics have improved in FY23 despite higher absolute debt. Also, power companies with strong revenue growth in FY23, despite margin contraction, have marginally improved their debt metrics in FY23.
While not an alarming rise by itself, companies and investors must assess leverage ratios in the face of a weaker operating outlook combined with higher expected cost of borrowings.
The time to assess would be post-end of the Q2 results season. Companies publish balance sheet data at the end of H1 and investors will have the data to gauge the updated financial and leverage metrics for India Inc.
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