The interest coverage ratio (ICR), or the ability of companies to meet their interest obligations from their operating profits, saw a noticeable improvement sequentially in the September quarter.
The ICR, calculated by dividing a firm's earnings before interest and tax or EBIT by the interest charges, of 2,077 BSE-listed companies (excluding banking and financial companies) rose to a high of 3.8 times since September 2019. In the June quarter, it fell to a low of 2.2 owing to prowling demand on strict stay-at-home restrictions to check the virus spread. Economic activity came to a standstill during this period that pummelled operating earnings of these companies by nearly 40 per cent year-on-year (y-o-y). Similar repercussions were felt in the March quarter when the restrictions were imposed in the concluding week -- the combined ICR stood at 2.3 while the operating profits of the firms plunged about 31 per cent, y-o-y.
"Improved combined interest coverage ratio shows that corporate India's ability to service interest has improved significantly in the previous quarter indicating the success of the govt policies in the recent past. Also, companies have cut down on their expansion plans as the demand environment in the economy was lurking due to lockdown. Their capacity to service interest can further improve as the expansion plans are still being pushed but the demand has increased significantly in the last quarter resulting in the increase in EBIT of the companies," says Gaurav Garg, Head of Research, CapitalVia Global Research Limited.
There is a sudden growth in demand amid the unlock phase in the economy which has resulted in the increase of the company's earnings which was lacking during the lockdown, he added. As a result, the aggregate EBIT of the sample grew 9.8 per cent, y-o-y, during the July-September 2020 period compared to a massive fall of 40 per cent in the previous quarter.
Meanwhile, the interest expenses of the firms declined 1.3 per cent, on a yearly basis in Q2FY21 versus a 6.7 per cent growth in the first quarter of the fiscal. "The decline in the interest expenses can be seen as a result of the relaxation in monetary policy and due to the recent policies of the government including moratorium facility on loans," highlights Garg.
ICR is a crucial yardstick and higher the ratio, the better is the company's safety margin. However, ability of a firm to pay interests becomes doubtful if the ratio deteriorates to 1.5 or lower. There were visible signs of easing corporate stress as the share of weak companies in the sample (IC<=1) fell to 33 per cent compared to 52 per cent in the previous quarter. Moreover, the number of weak companies, at the operational level, almost halved, from 915 to 498, during the last two quarters. "Majorly all sectors in the economy has seen a significant demand growth after the unlock process has started due to which companies have experienced improved earnings and hence their ability to service debt has also improved," Garg says.
Looking at the way demand has come back in the economy and positive sentiments in the market, Garg expects the trend to continue for the upcoming quarters to see more companies improving their ability to service debt in the future.
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