Equity boom to aid soft landing for Indian firms

Indian companies seem surprisingly well placed to handle any contagion from credit-related turbulence in the global markets.
The main worry in the markets has been that banks which hold the debts of over-leveraged companies, market players and individuals will see a piling up of bad debts which, in turn, will affect their future loans and investments. But in such a scenario, companies that have strong balance sheets and low debt are unlikely to be affected.
A Mint analysis of 217 Indian listed firms with market capitalization of more than Rs1,000 crore finds that their debt-equity ratio, a measure of their level of borrowing and their financial soundness, was a low 0.97 as on 31 March. This essentially means that for every Rs100 worth of equity, these firms are borrowing Rs97.
Commercial banks and information technology companies have been left out of this analysis, the former because the ratio of debt to equity is not a valid metric in analysing them, and the latter because they typically do not borrow.
Furthermore, despite the sharp rise in bank credit in the last few years and in the amounts raised abroad by way of external commercial borrowings, there has been hardly any change in the debt-equity ratio in the past five years.
That’s not all.
A sample of 1,427 listed companies with market capitalization below Rs1,000 crore, too, shows an improvement in their debt-equity ratio.
For this group, the ratio has fallen from 1.73 as on 31 March 2004 to 1.42 in 2007. During this period, the debt-equity ratio of large-cap firms with market capitalization of over Rs1,000 crore has moved only marginally by a few basis points—from 0.94 to 0.97.
How has this occurred in spite of the large external loans taken by companies?
“Don’t forget that stock markets have been booming in the last few years and Indian firms have raised a large amount of equity. This has lowered the debt-equity ratio,” says Veena Mishra, senior business economist with Mahindra & Mahindra Ltd (M&M). “Corporate profits have soared and companies have a lot of free cash flow and this has strengthened their balance sheets.” she says. Adds Vinay Patel, economist with ICICI Securities Ltd: “The stock of external debt hasn’t really gone up too much.”
Raman Uberoi, senior director at rating agency Crisil Ltd, points out the sharp improvement in the finances of companies rated by his agency.
“Our AAA-rated companies had a debt-equity ratio of 0.5 in 2001, which improved to 0.21 by 2006,” he says. For A-rated companies, adds Uberoi, the ratio improved from 1.5 in 2001 to 0.9 in 2006.
A recent Reserve Bank of India study on the finances of 1,064 non-financial, non-government large public limited companies showed that the percentage of debt to equity of these companies fell from 47.9% in 2003-04 to 36.4% in 2005-06.
The improvement has occurred because Indian companies have only recently started expanding capacity, which means they didn’t really need much funding. Also, they have become far more efficient in managing their working capital, which again reduced their demand for loans.
Interest rates, too, came down during the period, as a result of which they were able to service their debt more easily.
Points out Uberoi: “for Crisil-rated AAA borrowers, the interest cover (the number of times interest payments were covered by profits before interest and tax) improved to 19.75 in 2006, from 6.85 five years ago. For A-rated borrowers, the improvement in interest cover was from 2.48 to 5.36.”
Most brokerages remain sanguine to concerns that the recent tightness in the credit markets will hurt Indian companies.
Says Ajay Parmar, head, Ideas Research at Emkay Securities in Mumbai: “Corporate earnings growth remains strong and foreign investors will continue to flock to India. The strength of the rupee is an added attraction.” But Mishra of M&M is less sure. “It will hurt those companies that have taken bridge loans from banks, say for funding an acquisition,” she says.
Mukarram Bhagat, CEO and managing partner, broking services, of ASK Securities in Mumbai, says markets are worried about the possibility of higher costs of funding and of acquisitions abroad. “There’s no truth in the story that emerging markets are decoupling from the US,” he says. “If the US gets hurt, so do emerging markets.”
It’s true that the big-ticket acquisition deals of Indian corporates have been funded by foreign banks, which might suggest that if they face a liquidity crunch, acquisition financing could get affected.
However, Uberoi does not believe so, underlining the fact that while the debt-equity ratios of Indian firms will rise in the future on account of capacity expansion, they will still be at very low levels.
Adds Patel, “Although spreads on junk bonds in the US have gone up, they remain at historically low levels. Also, even in the US, most of the big companies are unlikely to be affected by any credit squeeze. As for the impact on Indian companies, it’s likely to be very manageable.”