High leverage a cause of concern for markets
Even as the market is touching new highs, the leverage ratios of Indian companies is not as enthusing. Our survey based on annual interim financials of 2,300 companies show that for the second year in a row, there has been progress, albeit modest, in deleveraging corporate balance sheets.
Thus, aggregate non-financial sector Ebitda has grown faster than growth in debt for the second consecutive year, as per provisional financial statements. With the fall in interest rates, aggregate Ebitda grew faster than interest expense for the first time in many years in FY17. While this is positive, the pace of progress is painfully slow.
Thus, aggregate gross debt is still 3.2x Ebitda, an improvement of only 20bps in FY17. Excluding the IT sector, which is largely debt-free, aggregate gross debt is 3.6x aggregate Ebitda, an improvement of just 10 bps in FY17 and 17 bps from the peak.
Therefore, although, headline leverage ratios generally improved for corporate India in FY17, it is not something from which we can draw much comfort. This is because the improvement was largely due to better profitability of the metals sector for which outlook is not great this year.
The metals sector saw a sharp improvement in its leverage ratio in FY17 as its profitability rebounded from highly depressed levels of FY16 — metals & mining Ebitda grew 50 per cent YoY in FY17. However, despite the improvement, aggregate debt of the metals and mining sector at 5x Ebitda is still high, especially considering that commodity prices have declined in the last couple of months. Excluding metals, leverage ratio actually increased in aggregate.
Further, highly leveraged companies have not seen any progress on deleveraging. The underlying corporate profitability is also weak with the proportion of companies making Ebitda loss at the highest in the past five years. We are thus no closer to resolving the twin balance-sheet problem at the end of FY17 than we were at the end of FY16.
Rather than hiding behind accounting solutions such as a bad bank, what is needed is that asset values should be written down to such levels that the ensuing debt can be funded by current cash flows.
This requires a legal environment whereby companies are forced to fall in line, which is enabled by the new bankruptcy law. Banks need to be recapitalised so that they can take the write-offs without further impairing their already weak balance sheets. More than anything, what is needed is a willingness to take hard decisions. There is no sign of that yet.