The mega churn

For every action, there is an equal and opposite reaction." Far from physics, Newton's third law of motion was in action in economics in 2015/16 as India Inc. braced for the combined onslaught of a global slowdown, two successive years of drought, a mountain of corporate debt and bad assets, high inflation, and a slow-to-revive domestic economy.

Take the case of crude oil, which fuels transportation and impacts every possible industry on earth. As global crude oil prices remained subdued right through the fiscal, the top line of domestic refining majors, some of India's largest corporates, shrank. This reduced the total income of BT500 companies (non-finance) by 5 per cent in 2015/16. And that triggered 'reactions' across India Inc. First, the overall valuation of the Top 500 companies fell 1.5 per cent. "It's not a function of value creation. Rather, of how much uptick they see from here," says Shashank Tripathi, Partner, Strategy&, and Leader, PwC India.

Lower oil and commodity prices had an opposite reaction on downstream industries, which benefited from lower input costs, expanding the total net profit of BT 500 firms by nearly 11 per cent. Better profits meant companies, in general, didn't have to halt asset creation, which grew nearly 9 per cent. Profits also made businesses viable enough to service loans, increasing BT500 companies' debt by nearly 8 per cent.

REALIGNMENTS GALORE

The ripple effect of such churn in the corporate world caused a year of realignment and upsets in BT500 rankings with as many as seven changes in Top 10 and 19 in Top 25. Investors punished India's largest bank, State Bank of India, for its pile of non-performing assets, or NPAs, by pushing it out of the Top 10 (8th to the 11th rank) this year. Equally, they rewarded HDFC Bank (with the lowest NPAs among top banks in the country) by taking it from No. 5 last year to No. 3 with 13 per cent jump in the average market cap. The spot vacated by SBI from the Top 10 was filled by Hindustan Unilever, which returned to the Top 10 this year after being out for two years.

HDFC Bank's promoter, HDFC Ltd, was the biggest gainer among the Top 10, jumping three places from 10th to 7th, as its net profit grew by nearly Rs 1,100 crore on a base of Rs 6,000 crore last year. As expected, the biggest hit was taken by upstream oil major ONGC. It went into a free fall, slipping from No. 3 to No. 9, as its average market cap fell by over Rs 81,500 crore.

Lower crude oil and commodity prices directly benefited user industries as their margins swelled without raising prices. For instance, Marico expanded margins by 450 basis points (bps), Asian Paints by 440 bps, Bajaj Electricals 430 bps, Godrej Consumer 350 bps and ITC 300 bps.

"These companies benefited because input costs came down. Their margins are better as they may not have passed on all the benefits of lower input costs to consumers," says Sanjeev Prasad, Senior Executive Director & Co-head, Kotak Institutional Equities.

IN ASSETS THEY BELIEVE

A healthy bottom line left enough moolah on the table for the BT500 companies as a whole to continue their asset creation efforts, despite a debilitating slowdown, low capacity utilisation and painfully slow growth in consumption throughout 2015/16. "It's not that nothing will happen in such a situation. Asset creation would be very strategic in nature," says Sunil Sinha, Director - Public Finance & Principal Economist, India Ratings & Research.

Besides Reliance Industries' ongoing expansion at Jamnagar, which increased its assets from just short of Rs 4 lakh crore to nearly Rs 4.6 lakh crore, it's the growth sectors such as telecom, auto, power, textiles and infrastructure that continued the trend of asset creation during the fiscal.

For instance, Bharti Airtel's assets shot up by Rs 38,000 crore. Power Grid Corporation increased its assets by more than Rs 22,000 crore, Larsen & Toubro by nearly Rs 11,000 crore and NTPC by Rs 21,000 crore. Among auto firms, India's largest carmaker Maruti Suzuki, which is setting up a new plant at Sanand in Gujarat, increased its assets by more than Rs 7,500 crore. Tata Motors' assets grew by nearly Rs 2,700 crore.

At the same time, asset creation came to a standstill in sectors such as FMCG, cement, real estate and durables where, despite improvement in consumption and demand, capacity utilisation is still hovering around the 70 per cent mark. At the Rs 35,000-crore Hindustan Unilever, for instance, assets grew by Rs 500 crore, and at Nestle India, just above Rs 250 crore.

DEALING WITH DEBT

Debt is the last thing you would expect to grow in the midst of shrinking revenue streams. Especially, when banks are piling up NPAs and companies are struggling to pay interest. But BT500 saw a near 8 per cent growth in debt during 2015/16. "When a lot of avenues for tapping liquidity (required for normal business) dry up, debt is the only option," says India Ratings' Sinha. "One-third or more companies require refinancing."

However, as expected, the rise in debt is far from secular. On the one hand is the trend of growth sectors such as telecom (53 per cent rise in debt), capital goods (12 per cent), transportation and logistics (11 per cent) and infrastructure (about 8 per cent) raising fresh debt. On the other hand, under increasing pressure from RBI - and consequently from the lender bank - in sectors such as cement, promoters have been forced to sell assets to pay off high-cost, unserviceable debt. Jaiprakash Industries, for instance, was forced by lenders to part with its hydro power and cement assets to pay off loans. In sectors such as automobiles, we saw refinancing of debt to reduce the interest burden. Tata Motors, for instance, reduced its debt by nearly Rs 5,000 crore to Rs 16,000 crore. Mahindra & Mahindra, Apollo Tyres and Maruti also managed to reduce their debts marginally.

Perhaps, this round of debt is being used more for running businesses and creating assets rather than just wild acquisitions. "Growth for growth's sake is gone, and that's good. Some unreasonable things were happening in terms of acquisition. People were expanding helter-skelter. Now, capability building is more in focus at companies. More responsible management has happened. Unless it's profitable growth, it's no growth," says Tripathi of PwC India.

The bigger challenge is for companies in sectors such as real estate, infrastructure and power, as they continue to be over-leveraged. "The infrastructure sector has no dearth of demand but companies are highly leveraged and can't service debt or go to the market to raise funds," says India Ratings' Sinha. They have little option but to raise funds by selling assets.

NEXT UP

With commodity prices rising and crude oil staying put at around $60 a barrel, top-line growth is guaranteed. But will a normal monsoon, lower interest rates and hike in salaries of government employees trigger a revival in the economy?

"The most dominant factor pushing up growth will be agriculture. It will be consumption-led, not investment-led, growth. We should see gradual improvement this year. Next year, private investment has to pick up to sustain growth," says Dharmakoti Joshi, Chief Economist, Crisil.

For companies to think in terms of investing in new plants, they need to be confident that capacities are near full utilisation. Interestingly, in sectors such as auto, durables, cement and steel, capacity utilisation is steadily inching up, from mid-60s last year to over 70-75 per cent in September 2016. In steel, for instance, the anti-dumping duty will cheer investors in steel, metals and mining industries. They can expect growth in top lines, apart from bottom lines getting back into the black.

"The capex cycle (growth) of 2005/08 was in high double digits - up to 30 per cent in some sectors. That's not been the case in the past few years. Gross fixed capital formation is negative. But overall, the worst is over. The economy is moving in a positive direction," says India Ratings' Sinha.

Photo: Shekhar Ghosh

The banking sector continues to face the dual challenges of NPAs impacting profitability on one hand, and near-zero offtake in corporate loans impacting revenue and loan books on the other. The retail banking business continues to remain the saviour for now, but the divergence of growth between corporate and retail banking businesses is not expected to narrow anytime soon. "Last year, several banks had a disastrous year. Banks should improve this year because lower loan-loss provisions in certain PSU banks should improve profitability," says Kotak's Prasad.

As for the stock markets, most analysts believe that - barring a world war or an armed conflict with our neighbour - Indian stock markets are expected to fare better in FY2017 than in FY2016. "Overall, the stock market in 2017 should be better than the March 2016 levels," says Ashish Gupta, MD & Head of Research, Credit-Suisse.

PwC's Tripathi also believes India is at the cusp of an entrepreneurship-led revival. "Entrepreneurship is being promoted at a large scale. If this carries on, the ease of doing business improves and large companies perform well, all this can form a good nexus," he says.

Going by the trends, more factors appear to be working towards an uptrend in the economic cycle than against it. Beyond that, with momentum in favour, Newton's law will take its course.

@rajeevdubey