Are Indian companies back on a borrowing spree?

Debt levels have risen in FY23

Too much of debt is never a good thing and that is exactly what has happened according to a recent study of 2,710 companies that have declared results for fiscal year FY23. Gross debt for FY23 was up 19% over FY22. That is a sharp spike after 2 consecutive years in which the debt levels fell by 4% and 2% respectively. It looks like the gains of deleveraging seen post the pandemic has not been carried into FY23. Even the larger names have been forced to add on to debt, a contrast to what they saw about 2 years back when deleveraging was the name of the game. But then debt always has a context and the context here is the growth in sales and growth in profits. How does the rise in debt look with reference to the growth in the top line and bottom line?

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Sales up, debt up but profits down

The sample of companies reviewed showed some interest numbers. The aggregate borrowings of Indian corporates stood at Rs25.9 trillion as of the close of FY23, showing a growth of 18.7% yoy. During the same period, the sales have grown by 23.3% to Rs87.1 trillion. That is an encouraging piece of data, which shows that the debt has been used to leverage higher sales. However, for the same period, the net profits were down by -6.9% at Rs6 trillion. On total debt of Rs25.9 trillion, even if you assumed an average cost of 10-12%, we are looking at interest cost alone being half of the net profits. That should be an area of concern as falling profits and rising debt would weaken the solvency ratios like the interest coverage ratios.

What triggered this spike in debt?

Broadly, the debt has been driven by capital-intensive sectors like oil & gas, power and metals which accounted for half of the debt. But a good chunk of the debt was also for working capital needs. For a better part of the year, the supply chain constraints continued and that put a lot of pressure on the entire working capital payment cycle. Companies were forced to offer liberal credit terms and also hold additional inventories to offset the supply chain issues. That means; a lot of the fresh debt funding was locked up in working capital. Above all, the higher cost of funds also meant that companies focused more on their operations than on deleveraging during the year. 

But, there is some good news too

While things may not look hunky-dory on the debt front, there is still some good news for the investors. Order books are overflowing, especially in the capital goods space, and that is likely to drive a lot of debt usage. That should not be an issue as it would also be revenue and profit accretive. Secondly, as some analysts interpret it, strong demand for debt exudes confidence on the part of the factory managers and the CFOs that demand would be robust and that debt servicing should not pose a problem. Above all, even if you look at the debt equity ratio as of March 2023; it has increased from 0.48X to 0.57X. That is still a very comfortable leverage scenario and hardly any reason for the alarm bells to start ringing. 

How will borrowings pan out in FY24?

The general view is that the working capital bulk may continue for some more time. Once companies shift to a more conservative working capital policy, they don’t change tack immediately. Also, on the capex front, we have not even started counting the multi-billion dollar capex that big groups like Reliance, Adani and Birla are talking about. These could keep the overall leverage levels under pressure for some more time. As long as the debt is value accretive, it should not pose any big problem for India Inc.

Content Source: Live Mint