Corporates are likely to show an unwillingness to invest in long-term projects due to muted demand and significant leverage, despite a low interest rate environment, says Priyanka Poddar.

 

Over FY18-FY20, growth in capex would be muted and overall corporate sector investment would grow by Rs 1 trillion (5-8 percent CAGR), primarily in the form of maintenance capex, according to India Ratings and Research’s 

(Ind-Ra) base case estimate based on moderate consumption demand, global overcapacity and working capital disruptions due to the goods and services tax. Corporates registered 4 percent CAGR growth over FY13-FY17, 13 percent over FY09-FY12 and 49 percent over FY05-FY08. Corporates are 

likely to show an unwillingness to invest in long-term projects due to muted demand and significant leverage, despite a low interest rate environment.

 

During the period, maintenance spending will be incurred by the 125 non-stressed corporates of the top 200 asset-heavy corporates. The capex of these corporates expanded at a 10 percent CAGR over FY12-FY17. Moreover, these corporates represented 80 percent of the total capex spending of the top 200 asset-heavy corporates over FY12-FY17, with a capacity utilisation of 75-80 percent. These 200 entities account for about 85 percent of the overall capex spending by India Inc. 

 

However, the 75 stressed corporates, which registered negative 11 percent capex CAGR for FY12-FY17 and are from key investment-linked sectors, such as metals and mining, infrastructure, and power, may not even be in a position to incur maintenance capex. Thus, they are likely to drag down the investment recovery for another two-three years. The 75 stressed corporates represented 20 percent of the total capex spending over FY12-FY17, with a capacity utilisation of 40-50 percent.

 

Ind-Ra believes growth capex beyond FY20 will be driven by the 125 non-stressed corporates, given their strong financial profiles and low leverage levels. While the implementation of the Insolvency and Bankruptcy Code, 2016 (IBC), is likely to streamline debt resolution through debt reduction options for stressed corporates, the low capacity utilisation of 40-50 percent of stressed corporates would lead to a pull-back of investments by the non-stressed corporates. 

 

Moreover, the risk-averse behaviour of the banking sector, especially public sector undertakings (PSUs), and NPA challenges faced by banks would increase their reluctance to lend to the fresh projects of stressed corporates. While liquidation under the IBC 2016 could lead to supply constraints, giving opportunities to the non-stressed corporates to expand capacity, growing competition and increasing M&A activity will result in the consolidation of the stressed corporates. This will push back any large-scale, debt-funded capex by the non-stressed corporates.

According to India Ratings, the majority of stressed corporates would require another four-five years to deleverage to a sustainable level of 4x-5x from their current leverage of 9x-10x, provided the economic and financial activity reaches the FY09-FY12 level. However, at the current level of economic activity, it could take another 10-11 years for such corporates to deleverage to a sustainable level. In a scenario where overall capacity utilisation (aggregated for the top 200 capex spenders) continues to remain at 60-65 percent, the 5x median net leverage (highest since FY05), muted demand growth and weak pace of nominal growth recovery (resulting in low EBITDA), capex activity may not revive even in the next seven-nine years.

 

Ind-Ra believes incremental investment will be made by the private sector, considering the contribution of PSUs in the overall capex is falling and their profitability is deteriorating. Private corporates’ capex and EBITDA increased at a CAGR of 2 percent and 11 percent over FY12-FY17, respectively. On the other hand, PSUs registered a 7 percent CAGR for capex over FY12-FY17, with their profitability rising at a CAGR of 1 percent during the period. The share of PSUs in the total capex declined to 30 percent in FY17 from 46 percent in FY06.

 

Asset-heavy sectors under stress

 

The top five asset-heavy sectors (ie infrastructure and construction, metals and mining, power, telecom, and oil & gas) accounted for 80 percent of the adjusted gross block and 75 percent of the annual capex in FY17. Capacity utilisation was muted across sectors over FY15-FY17. Ind-Ra believes there are pockets of stress within sectors, especially infrastructure, metals and power (particularly thermal) owing to high leverage and weak cash flow, limiting their ability to incur large-scale, debt-funded capex. 

 

These sectors witnessed a significant decline in capacity utilisation - 20-30 percent deterioration from the peak FY06 levels (80-90 percent). Until these core sectors focus on deleveraging or significant equity infusion, they are unlikely to make significant efforts towards capacity expansion. However, sectors with comparatively low leverage and higher capacity utilisation, such as oil and gas, auto and telecom, could incur marginal capex growth over FY18-FY20.

 

Credit supply constraints

 

In Ind-Ra’s opinion, even if consumption demand picks up, there would be credit supply constraints with regard to providing fresh credit to corporates by the banking sector owing to risk aversion and higher recapitalisation needs. The role of ARCs in providing support to banks is likely to be minimal, given their capital constraints and valuation mismatches. Therefore, new investments may need to explore capital markets and non-banking financial corporations for funding. The majority of capex will be driven by ‘AAA’- and ‘AA’-rated entities (75 percent contribution to the total capex). Ind-Ra believes both capital markets and non-banking financial corporations have limited appetite in terms of size and risk to absorb long-tenure funding requirements of corporates.

 

Government spending (both central and state) on capex increased in absolute terms over FY16-FY17. However, its growth (FY17: 6 percent yoy; FY16: 40 percent yoy) and share as a percentage of nominal GDP have been decelerating. Despite the expected fiscal stimulus and higher government spending due to incremental revenues on account of the goods and services tax, the overall investment cycle is unlikely to revive due to a weak corporate capex performance and the limited ability of the government to scale up spending owing to fiscal rectitude.

 

Priyanka Poddar is the Senior Analyst at India Ratings and Research Pvt Ltd