Earnings dip may test firms with high debt

Metal firms may face immediate impact because of fall in international prices

The next few months will test the financial resilience of Corporate India, as India Inc is staring at a sharp cut in revenue and earnings, thanks to a combination of the recent fall in commodity and energy prices, and lower demand for goods and services because of the economic disruption caused by the coronavirus outbreak.

Analysts see an immediate impact for companies in metals and mining, and oil and gas sectors. However, risk aversion in the financial markets could also impact capital-guzzling firms in sectors like nonbanking finance and infrastructure. “The recent fall in metals and energy prices would translate into low margins and profits for most firms in these sectors for at least a few quarters. Many companies could also report losses,” said Madan Sabnavis, head economist at CARE Ratings.

Any sharp decline in profitability could be financially painful for companies with large debt and low interest coverage ratio (ICR). ICR is a measure of a company’s debt servicing ability and is calculated by dividing its operating profits by its interest liability. A higher ratio is preferable, and a score below 1.5 indicates a small fall in margins or profits could force it to default on interest payments.

Others say that the most pain will be felt by companies with high promoter pledges. “Most vulnerable are companies with a combination of high debt and high promoter’s pledge,” say G Chokkaligam, founder and managing director of Equinomics Research & Advisory Services.

On this front, most of the country’s metal producers could face financial headwinds in the forthcoming quarters. Tata Steel, for example, reported ICR of 2.2x during the first nine months of financial year 2019-20 (FY20), down from 4x a year ago. The company’s operating profit was down 46 per cent year-onyear (YOY) during the period, while its interest obligations were down around 2 per cent YOY.

The steelmaker had a total debt of around ~1.24 trillion on a consolidated basis during the first half of FY20, while its market capitalisation was down to around ~32,300 crore, making it tough for the company to raise fresh equity capital.

Similarly, Steel Authority of India’s (SAIL’S) ICR declined to 1.7x in the period under consideration, down from 3.2x a year ago. The firm’s operating profit was down 41.1 per cent YOY in the first nine months of FY20, while its interest obligations were up 9.6 per cent YOY during the period.

Other companies with low ICR in the sector include Jindal Steel & Power and JSW Steel.

Infrastructure and power companies with large debt could also face headwinds if there is a significant fall in their earnings over the next few quarters. Equity investors have already discounted these firms with a large decline in their market capitalisation in recent months.

IRB Infrastructure Developers — the country’s top highway developer — reported a 6 per cent YOY growth in its operating profit in the first nine months of FY20, while its interest obligation was up 43.1 per cent during the period, leading to a sharp decline in its ICR. The company’s market capitalisation is less than 10 per cent its total outstanding debt.