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Extreme Stress

India Inc. must brace up for large-scale ratings downgrade, defaults and assets sale
twitter-logo Nevin John & Niti Kiran Print Edition: October 18, 2020
Extreme Stress
Illustration by Raj Verma

"The only man who sticks closer to you in adversity than a friend is a creditor," 62-year-old Harsh Goenka, Chairman of RPG Enterprises, quotes a famous line to describe the current predicament of corporate India whose debt in stressed sectors amounts to Rs 37.72 lakh crore, nearly 38 per cent of all loans given by the banking sector.

The magnitude of stress is akin to Black Swan events such as the global financial crisis of 2008 or the Great Depression of 1929 when thousands of companies had to file for bankruptcy.

India Inc., already under pressure due to several quarters of falling GDP growth, and dealt a severe blow by recent lockdowns, is staring at massive ratings downgrade and loan defaults.

The reason: Its capacity to service debt is weakening due to low capacity utilisation and falling revenues and profits, triggering a flurry of actions ranging from sale of assets/stakes, shutting down of stressed businesses, frenetic fund-raising and sharp, almost brutal, reduction in costs. This will particularly hurt firms with high debt and low interest coverage ratio, or ICR, which measures how many times a company's earnings can cover current interest payments.

Those with low ICR include giants such as Anil Agarwal's Vedanta Ltd, Gautam Adani's Adani Power and Sunil Mittal's Bharti Airtel. Many of them can tide over the crisis with support from other group companies and assets (L&T, for example, plans to reduce its Rs 1.24 lakh crore debt by Rs 30,000 crore by March 2021 by selling L&T Infrastructure Development Projects and Nabha Power and transferring Hyderabad Metro stake to an investment trust). However, further worsening of the economic environment could spell trouble for the giants too. Vedanta did not repond to BTs queries while Bharti Airtel says lenders do not have issues with its debt and its ratings, in fact, were upgraded recently after a favourable ruling in the AGR case.

BT research shows ominous signs right from the September 2018 quarter when growth in gross sales and operating profits started declining. Things came to a head in Q1 of FY21 when 2,803 companies (ex-BFSI) reported aggregate loss of Rs 9,725 crore as against Rs 91,587 crore profit in Q1 of FY20-a drop of over Rs 1 lakh crore. Gross sales growth has been negative for four straight quarters now. There has been a consistent fall from 23.4 per cent growth in September 2019 quarter to -37.5 per cent in June 2020 quarter.

It's a matter of time before downgrades/defaults start biting India Inc. A rating downgrade raises cost of funds, making interest servicing even tougher. Higher cost of capital also depresses equity prices, shrinking options for raising money from stock markets.

Downgrade Risk

Take Tata Motors. The company's ICR turned negative in March. In a post-Covid review, in June, Moody's downgraded its debt by a few notches. The automotive division is saddled with Rs 67,800 crore debt. Its net debt to equity ratio rose from 0.84 in June last year to 1.44 in June this year. Tata Group Chairman N. Chandrasekaran has targeted making the company net debt free in three years. Credit rating agencies are not convinced. "The downgrade reflects sustained deterioration in the automaker's credit profile," Moody's Vice President and Senior Credit Officer, Kaustubh Chaubal, said in his report.

Tata Motors is a perfect case of a company whose stress was already high but got aggravated due to demand collapse post-Covid. "The pandemic has amplified pressure on Tata Motors' cash flows and will likely result in a prolonged period of weak credit metric," says Chaubal. With people expected to stay away from big purchases such as cars, it could be a while before things turn for the better. Tata Motors did not respond to queries from BT.

Tata Motors is not the only one. ICRA downgraded ratings of 584 entities in FY20, reflecting a downgrade rate of 16 per cent. The annual average of previous five years was 9 per cent. The volume of debt downgraded was a staggering Rs 7 lakh crore as compared to the five-year average of Rs 3 lakh crore. The coming downgrades due to sharp fall in GDP - most expect it to shrink 10 per cent-plus in FY21 -will create another chain of defaults, restructurings, stake/asset sales and liquidations. Arguably, corporate India may never be the same again.

The Debt Volcano

Ajay Piramal's Piramal Enterprises was in the middle of a de-leveraging exercise when Covid stuck. RBI's loan moratorium for Covid-hit companies came as a gift of God. The breathing space allowed it to get on board private equity investor Carlyle Group, which bought a 20 per cent stake in its pharmaceutical business in the middle of a raging pandemic for Rs 3,700 crore. Of this, Rs 3,400 crore will flow into holding company Piramal Enterprises and be available for reducing debt. The company has managed to bring down its debt from Rs 52,000 crore to Rs 38,000 crore in past one year.

But Piramal Enterprises' success with debt reduction is more an exception than the norm in India Inc. For most, a severe debt crisis was avoided when India put a lid on it by announcing a six-month loan moratorium for stressed sectors. Latest data shows corporate loans of Rs 37.72 lakh crore, including to MSMEs, are under moratorium. India's largest ratings agency, CRISIL, which has analysed 2,300 companies that opted for the moratorium, says 75 per cent of these are sub-investment grade. Not all will get the benefit of the two-year loan restructuring window the RBI has opened for companies that are facing stress only due to Covid-related disruption.

Subodh Rai, Senior Director at CRISIL, expects more rating downgrades than upgrades to continue for more quarters due to economic slowdown. However, there are a host of sectors where recovery is likely to take much longer. These include construction & real estate, telecom, steel and power, which were under stress in the pre-Covid period too. Over Rs 22.20 lakh crore debt is parked in such sectors.

One of the biggest pain points is construction and real estate bank loans of Rs 3.32 lakh crore. Niranjan Hiranandani, Co-Founder & MD, Hiranandani Group, says debt is just one part of the problem. The second is continued access to credit for growth and working capital. "The volume of corporate defaults looming over the real estate sector can at best be a guesstimate but the numbers will be huge," he says. "The economy has been impacted and buyer sentiment hit. Sales have been down and ability to service debt impacted. Things can become really challenging for some balance sheets," says Hiranandani.

Lenders to real estate are also impacted. Piramal Enterprises will have to support its financial services business as it has a large real estate portfolio. It will not be easy as companies are giving up office spaces due to poor demand and the growing trend of work from home.

In steel, the big companies with cash buffers continue to maintain cash flow to meet fixed costs through exports--even to China. "But medium and small companies are struggling as they became financially weak while competing with the five-six big players in the market which itself has shrunk considerably," says Seshagiri Rao, Joint Managing Director and Group Chief Financial Officer, JSW Steel. Bank loans to the steel sector are in the region of Rs 2.66 lakh crore.

The four power majors in the list of the 20 most indebted companies have a combined gross debt of Rs 1.63 lakh crore with Adani Power topping the list. The current crisis has delayed the commissioning of its 1,600-MW ultra-supercritical, coal-based thermal power project in Jharkhand. The company has evoked Force Majeure clauses under the Power Purchase Agreement. An Adani Power spokesperson says they have significant unrealised claims on various Discoms towards compensatory tariff claims. "Adani Power aims to reduce its leverage and improve liquidity with the help of funds from resolution of claims and pending dues from Discoms," he said.

Auto is another area facing rough weather. R.C. Bhargava, Chairman, Maruti Suzuki India, says the industry is improving every month but is not normal yet. "We are still not where we were two-three years ago," says Bhargava, whose company doesn't have significant financial liabilities. But some industry players could be affected. "It will be difficult for everyone as nobody knows the demand scenario after the festival season. It is fine now, but is not clear whether it will sustain and grow post-December. That will decide the industrys health," says Bhargava.

Going forward, capital intensive sectors that were struggling prior to Covid and where the situation got exacerbated due to the pandemic would face bigger challenges. "These sectors may necessitate long-term solutions," says Valecha of India Ratings.

Asset Sales to the Rescue

G.V.K. Reddy, the Chairman of GVK Group and face of India's infrastructure revolution, had been facing debt issues for years. Post-Covid, financials of its marquee asset, the Mumbai International Airport, got hit due to flight ban. The six-month loan moratorium did help but the 83-year-old first-generation entrepreneur had no option but to onboard a financial investor, the Adanis, in the airport.

Adanis will provide the much-needed liquidity to Mumbai International Airport to meet debt and other obligations. This will also help the company achieve financial closure for the Navi Mumbai International Airport project. "It is under these circumstances that we agreed to cooperate with Adani so as to achieve these twin objectives," says Reddy.

For the past decade or so, old economy sectors such as infrastructure, steel and power were facing the most stress. But now, due to Covid, it is the turn of new sectors such as hospitality, travel & tourism, airports, entertainment and retail. Arvind Fashions Ltd, Ahmedabad-based Lalbhai Group's retail arm, had to keep stores shut in the initial phase of the lockdown. The impact on cash flow forced the company, with brands such as Arrow, Tommy Hilfiger and Calvin Klein, to opt for the loan moratorium. While 80 per cent of its stores are now open, its sales in August were only 46 per cent of usual. India Ratings has predicted 40-45 per cent revenue dip for the apparel retail sector this year. In the last two months, Arvind Fashion has managed to strengthen its balance sheet by selling a stake to Walmart-owned Flipkart and raising Rs 400 crore through a rights issue. It has also transferred the wholesale trading business of the Flying Machine brand to wholly-owned subsidiary Arvind Youth Brands which will generate Rs 62 crore for the company. Arvind Fashions did not respond to BT's query on whether it is approaching banks for loan restructuring.

Similarly, drugmaker Wockhardt has sold a part of its domestic branded formulations division, along with a manufacturing facility at Baddi in Himachal Pradesh, to Dr. Reddy's Laboratories Ltd for Rs 1,850 crore. The company, which went through corporate debt restructuring in 2012, had a debt of Rs 1,875 crore in March. The deal will deleverage its balance sheet.

Just before the virus outbreak, GMR Infrastructure was looking at options to pare its over Rs 32,000 crore consolidated debt. But the lockdown seriously hit its airport business. Consolidated net loss for quarter ended June 30 more than doubled to nearly Rs 834 crore. The company has now announced divestment of the group's entire stake in Kakinada SEZ Ltd to Aurobindo Realty and Infrastructure Private Ltd. The equity stake, including the sub-debt in KSEZ, has been valued at Rs 2,610 crore. GMR had, in February, also agreed to divest a 49 per cent stake in GMR Airports Ltd to French company Groupe ADP for Rs 10,780 crore in two stages. But, in July, it modified the second stage of the deal in the wake of the plummeting airport traffic.

Shutdowns And Exits

Kishore Biyani's mantra has always been rapid expansion. It got him the title of India's retail king. It has also been the source of his debt troubles. He sold his flagship Pantaloons Retail to Aditya Birla Retail a few years ago to save Future Group's retail business. That journey, too, hit a roadblock in March, when shares of Future Group companies lost significant value, leading to ratings downgrade of the promoter holding company and invocation of pledged shares by lenders. The virus outbreak further worsened the cash position of group companies. Future Retail defaulted on interest payments in July. Recently, Future Consumer defaulted, followed by Future Enterprises' default on interest payment on non-convertible debentures. Biyani had no option but to sell his food and fashion retailing business, including Big Bazaar, fbb, Foodhall, Easyday, Nilgiris, Central and Brand Factory, besides the logistics and warehousing business, to Reliance Retail Ventures (RRVL) for Rs 24,713 crore. Reliance will also take over certain loans and liabilities.

After the deal, RRVL will hold a 13.14 per cent stake in Biyanis Future Enterprises Ltd (FEL). RRVL will enter into a long-term agreement with FEL for sourcing branded fashion and FMCG products. FEL will have the freedom to sell to other retailers.

Experts say RRVL's pace of growth, both organic and inorganic can cause more stress in the retail sector, just like in telecom, where entry of Reliance Jio created huge pressures for the other two big players, Vodafone and Bharti Telecom. The retail sector will also face stress from digital models, slowdown and low footfalls in markets and malls. The last one has already proved to be the nemesis of eight-year-old gaming and entertainment provider Smaaash Entertainment, which was under financial stress earlier also, but could not survive Covid. Cash flow dried up as its business, with 45 branches across India offering activities such as indoor cricket and gokarting, was closely linked to malls. Smaaash did not respond to BTs queries.

Fire Fighting & Big Lessons

The 139-year-old Thomas Cook (India) Ltd, which has seen many business cycles, focussed on payroll costs, marketing spends, rental payments, fixed costs and better debtor management to survive the lockdown. The travel industry has global linkages. That is why there is little hope of recovery any time soon. Moody's has said that it does not expect a return to pre Covid volumes until 2023 at the earliest. The bigger worry is the Rs 50,000 crore bank debt in tourism, hotel and restaurant sectors.

Biggies have also been feeling the heat. Reliance Industries Ltd had to cut salary of its employees and executives in the oil and gas division by 10-50 per cent. The cash-rich Tata Sons, the holding company for the Tata Group, too, initiated cost-cutting measures. Tata Steel increased liquidity levels to Rs 20,000 crore-plus as a buffer. Tobacco-to-FMCG major ITC plans to sell businesses such as consumer lifestyle in case they do not align with strategic objectives of the group.

"Corporates are re-looking at real estate, infrastructure and the entire cost model," says Abizer Diwanji, National Head, Financial Services, EY India. "Some are cutting down on capex. A large number have managed to beef up liquidity funding wherever feasible," says Rakesh Valecha, Senior Director, India Ratings.

PVR Ltd, a market leader in terms of screen count, has raised confidence capital of Rs 300 crore through a rights issue. "We have seen some companies looking at rights issue. This prevents dilution of promoter stake. I think raising equity will be the last resort for companies," says Venkatraghavan S., Managing Director and Head, Equity Capital Markets, Equirus Capital. There will be more IPO and QIPs in the next half of the year. "There are estimates that Rs 50,000 crore worth of equity could be raised by March next year," he adds.

In the debt market, only AA-rated paper is in demand. "The top 100 companies have not seen much damage in market capitalisation but they also dont need capital immediately. In case of companies after top 100, the market cap hasnt recovered to pre-Covid levels. These companies are a bit hesitant in raising capital as it will result in higher dilution given that their share prices have not recovered to that extent from the Covid sell-off," says Deepak Jasani, Head of Retail Research at HDFC Securities.

"Internally, we continue to focus on optimising our expenses and conserving cash constantly, looking for areas to reduce costs and take up only critical spends," Amit Syngle, Managing Director and CEO of Asian Paints, said during a recent interaction with analysts.

Rao of JSW Steel, however, says credit flow was a problem even pre-Covid. But there were other sources of financing such as mutual funds, insurance companies, foreign portfolio investors and non-banking financial companies. Commercial papers were majorly funded by mutual funds. "When credit flow has stopped from other sources, banks are also not lending. This logjam has to be cleared," he says. The industry is also complaining that low interest rates are available to only those with triple-A rating. "In the last 18 months, the RBI has reduced the repo rate by 2.5 per cent. But SBI's MCLR has come down only by 1.15 per cent. This means not even 50 per cent of the cut has been passed on to consumers," says Rao.

Experts have predicted a V-shaped recovery for services sectors such as hospitality and tourism when the situation normalises. The services sector, which contributes over 50 per cent to the country's GDP, is likely to grow the fastest if the economy revives. "But we dont know when our economy will start drafting the V," says Diwanji of EY India. A big fear is the second wave of Covid infections which may trigger more restrictions. The UK government, for example, is toying with the idea of going for a second lockdown. Segments most impacted by social distancing such as tourism, travel, theatres or malls and restaurants are likely to take months to get back to normalcy.

Till a year ago, companies, banks and global investors were preparing for the economy to double to $5 trillion with 8-9 per cent growth over the next five years. "That hope is gone with Covid. It has further accentuated corporate stress," says Diwanji of EY India.

With the threat of downgrades and default rising, the corporate sector is tightening its belt, and so are risk-averse banks and creditors. Banks are keen to lend to corporate India, but with a caveat. "There is absolutely no point pumping in money into assets expecting that the bank will be able to recover the money in future," says K. Ramachandran, Executive Director at Indian Bank.

Only steadfast focus on economic growth and adequate liquidity can get India Inc. out of this mess.

@anandadhikari, @nevinjl, @nitikiran

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