Steep raw material prices are already hurting India Inc. To top it, the Reserve Bank of India has signaled that interest rate hikes are coming.
Economists expect the first hike in June. Unsurprisingly, analysts polled on Bloomberg have downgraded their FY23 June quarter earnings per share (EPS) estimates for Nifty 50 companies by 8.9 per cent.
Can India Inc stomach double trouble? Not quite.
An analysis of Nifty 500 universe indicates that nearly 52 per cent of companies or 218 out of 415 (excluding banks and financial services) saw their interest coverage ratio deteriorate in the last four years — that is, from 2018’s peak rates to the lowest ever of 4.5 per cent that has been prevailing March 2020.
Deterioration in interest coverage was particularly high in sectors such as automobiles, consumer discretionary, hotels, chemicals and real estate while it improved for sectors such as cement, steel, tyres, power and fertilizers.
In case of companies such as Tata Motors, Aditya Birla Fashion and Indian Hotels, for instance the interest coverage ratio dip into the negative zone in December 2022 quarter (Q3 FY22).
To put things in context, interest coverage ratio is an indicator of a company’s ability to pay its interest on loans. A higher ratio means the company is financially healthy to service debt.
If the number gradually reduces, it is suggestive of pain in the financials. A negative ratio implies that a company isn’t generating enough operating profit to meet its financial obligations.
Risk to FY23 earnings
Earnings improvement in FY21 was largely driven by cost curbs including low interest rates.
For the Nifty 500 stocks, despite the 7 per cent year-on-year fall in revenues, net profit grew by 56 per cent year-on-year in FY21, thanks to numerous cost reduction measures undertaken by India Inc and ample support from RBI in the form of low repo rate.
With the banks passing on the cost benefit to borrowers, companies used it to pare debt.
In FY22, even as operating expenses increased by 40 per cent, lower interest cost and the robust growth in revenues post the Covid slump have driven net profit growth for Nifty 500 companies for the nine-months ended December 2021.
In fact, debt-equity ratio — which is a measure of leverage — has reduced to 0.55x for the half year ended September 2021 from around 1x in FY18.
Despite these tailwinds, at least half the Nifty 500 companies have seen interest coverage ratio decline since FY18.
Things are changing once again, with input costs rising faster than anticipated because of the Ukraine conflict.
In spite of the 8.9 per cent EPS downgrade in June quarter of FY23, the full-year estimates for Nifty 50 earnings — at about ₹823 per share — remains almost intact, and this could be on the hope of faster- than- expected pick-up in revenue growth.
However, if interest costs play spoil sport, a blow to earnings across the board may be unavoidable.