The interest paying ability of companies (excluding banking, financial services and insurance, and public sector oil marketing companies) in the S&P CNX 500 Index has dipped to a five-year low due to high interest rates and a decline in operating profits, according to a Crisil Research report.

Interest paying ability is measured through interest coverage ratio, calculated as earnings before interest and taxes (EBIT)/ interest. The median interest coverage ratio fell to 4.8 times in the July-September 2011 quarter against 7.8 times in July-September 2010.

The average interest coverage ratio for these companies, totalling 420, in the past five years was 8.4 times.

The number of companies with an interest coverage ratio below two times rose sharply to 117 in July-September 2011 from 69 in July-September 2010.

Slowdown factor

“While the interest rate cycle has largely peaked, we believe that interest coverage ratio will remain under pressure over the next few quarters as corporate India's sales growth could slow down on the heels of lower GDP growth,” said the Crisil report.

According to Ms Roopa Kudva, Managing Director and CEO, Crisil, “While interest coverage is still healthy at 4.8 times, the magnitude of drop over the past few quarters is high. Economic uncertainty in the Western economies combined with lower GDP growth expectations at home could potentially push Indian companies into a slower revenue growth phase.

“This could increase the pressure on profit growth and result in further deterioration of interest coverage ratio.”

Rising interest cost

During the July-September 2011 quarter, interest cost rose by 36 per cent year-on-year (y-o-y) for the companies under study, as the Reserve Bank of India increased interest rates to curb inflation.

The silver lining, according to per the study, is that the median debt-equity ratio (gearing) has declined marginally over the past two years.

The study also reveals that in the July-September 2011 quarter, for the first time in the past eight quarters, operating profit and reported profit after tax have declined on a y-o-y basis. The last decline was in July-September 2009 quarter, during the last financial crisis.

Rising input costs exerted pressure on profit margins, although increase in sales somewhat moderated the impact.

Mr Tarun Bhatia, Director, Capital Markets, Crisil Research, said “On a sectoral basis, FMCG, information technology and pharmaceuticals have low gearing and fare best on the basis of interest coverage metrics.

“Our study reveals that stocks in these sectors have outperformed the S&P CNX 500 Index by an average 23 per cent over the past one year. On the other hand, companies with low interest coverage ratio, in sectors like infrastructure and real estate have underperformed the index by an average 20 per cent over the past one year.”

Related Topics