STATE OF THE NATION - Crisil

September 2013

STATE OF THE NATION

Exports

High interest rates

Challenges

Inflation Banking

Hotels Steel

Construction

CAD Gold

Volatile Rupee

CAD Mining Oil imports

CAD

Commercial Vehicles

High interest rates

Infrastructure

Investments CAD Capital goods

Challenges

Volatile Rupee Construction

Challenges

Banking

Real estate

Hotels

Volatile Rupee

Oil imports Construction

Tractors

Textiles

Two Wheelers

Monsoon

Leather

Pesticides Tractors Silver lining

Consumer Durables

Construction

Real estate

Textiles Pesticides

IT-ITES

Transport

Hotels Banking Corporate Inflation Profitability Oil imports Transport

Agriculture Leather Handicrafts Food prices

CAD

Fiscal Deficit

Working Capital

Transport

Exports

Consumer Durables

Corporate Profitability

Exports

IT- ITES

Silver lining

Pesticides

Inflation

Tractors

High interest rates

Working Capital Silver lining Cement Capital flows

Telecom

IT-ITES Textiles Monsoon Leather

Steel

InflationHigh interest rates Banking

Agriculture

Hotels Steel

Silver lining Pesticides Monsoon

Pharmaceutical

Tractors Food prices

Hotels

Concern Corporate Concern Profitability

Food prices

Two Wheelers

Banking

Mining

Real estate

Exports IT-ITES

Working Capital

Two Wheelers

Transport

IT-ITES

Companies

Transport

Sectors

Tractors

Economy

CAD Volatile

High Real Estate Rupee Interest Rate Commercial Vehicles Cars

THE

THE

AND THE

GOOD BAD UGLY

STATE OF THE NATION Economy Sectors Companies

STATE OF THE NATION

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STATE OF THE NATION: economy, sectors, companies CRISIL is pleased to present its first State Of The Nation report, a unique top-down-meets-bottom-up analytical exercise. For perspective, let us give you its sweep. This is about the power of stringing together deep analyses from the micro to the macro level. We started with granular data on 2,481 companies that CRISIL rates as investment grade. Then we leveraged our industry research spanning more than 70 sectors. Our industry analysis is supported by strong on-the-ground inputs through primary sourcing from players, vendors, distributors, industry associations and lenders. Finally, we brought in our macroeconomic research capabilities and profound understanding of risk. What you get is a comprehensive portrait of the economic state of the nation like no other. For example, our assessment shows that contrary to popular belief, forex volatility is a source of material vulnerability for only 6% of the 2,481 CRISIL investment grade companies that account for 32% of banks' corporate lending. What’s most stressful is the demand slowdown. And how does it look overall? While it may seem all dark out there – with falling corporate sales, falling currency, falling GDP growth juxtaposed with rising crude oil prices, rising inflation and a wide current account deficit – there are flashes of hope. To be sure, two-thirds of the major sectors are being hit by declining sales growth as GDP growth limps to a decadal low, even as the twin blows of high crude oil prices and weak rupee rub salt. Those suffering the most are the domestic-demand-driven sectors such as cement, steel, power, construction and automobiles. But, as in life, there are two sides to the story. The falling rupee is manna from heaven for exporter-companies from the information technology, business process outsourcing, pharmaceuticals and textiles space. And, after a long time, telecoms will do well due to improved pricing power. Watch out for agriculture too - it has the potential to surprise on the upside. In this milieu, CRISIL decided to take a leaf out of Sergio Leone’s famous trilogy of westerns from the Sixties – the third one to be precise – Il Buono, Il Brutto, Il Cattivo, a.k.a, The Good, The Bad and The Ugly, to paint the state of the nation. Read on to get the picture.

Roopa Kudva Managing Director & CEO

STATE OF THE NATION

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Table of Contents Page No. Executive Summary ------------------------------------------------------------------------------- 1 The Economy ---------------------------------------------------------------------------------------- 5 The Sectors ------------------------------------------------------------------------------------------ 11 How Vulnerable Is India Inc? ------------------------------------------------------------------- 17 n

Key Findings ------------------------------------------------------------------------------------ 21

n

Methodology - Annexure 1 --------------------------------------------------------------------------------- 26 - Annexure 2 --------------------------------------------------------------------------------- 28

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Executive Summary

1

STATE OF THE NATION

THE GOOD AGRICULTURE BOUNTY ON ITS WAY Timely, well-distributed monsoons and a 6.8% increase in the kharif sowing area mean agriculture would probably be the only sector to surprise on the upside. Farm GDP growth could more than double from last year's 1.9% to 4.5% (we now add 100 bps to our July forecast of 3.5%). This will help check food prices, support consumption in the rural areas, and improve sales of tractors and two-wheelers. If India gets lucky and agriculture growth surges 6% (we have seen this happen in 2010-11 when, after a good monsoon, it had rocketed 7.9%), overall GDP growth could be a much better 5.2% compared with our 4.8% call. BOOST FOR EXPORTS With a weak currency and improving growth prospects in advanced economies, exports will gain. Sectors such as textiles, leather, pharmaceuticals and IT-ITES have improved. This will help pare the trade and current account deficit. FOREX RISK NOT ALL THAT HIGH Here's the counterintuitive bit. Despite the significant depreciation in the rupee, foreign exchange vulnerability is the least of the stress factors impacting the credit profile of as many as 2,481 firms rated in the BBB- and above (investment grade) category by CRISIL (these firms account for about 32% of the banking system credit to corporates and 82% of CRISIL-rated debt). That sure flies in the face of conventional wisdom, but a caveat is in order: the universe of CRISIL-rated firms does not include many of the major groups such as Essar, GMR, GVK, JSW, Jaypee and Videocon that are trapped in Ground Zero of the currency maelstrom.

THE BAD INFLATION RISING Surging crude oil prices and falling rupee will push wholesale price index (WPI) inflation higher than 6% even as domestic demand slows. This will make it difficult for the Reserve Bank of India (RBI) to nudge interest rates south and will cause stress in leveraged sectors such as infrastructure and real estate. NO ROOM FOR STIMULUS The heavy burden of oil subsidies and declining growth in tax revenues will lead to slippages in the fiscal deficit, which is expected to bloat to 5.2% of GDP from a budgeted 4.8%, leaving no scope for stimulus. BULWARK SERVICES WEAK The services sector has been the mainstay of the economy for some time now. But the sharp and sustained slowdown will weaken sectors dependent on domestic demand, such as trade, hotels & restaurants, transport, banking, financial & business services and real estate. However, IT-ITES provides some offset. Overall, services will grow around 6.5%, a pale shadow of the nearly 10% growth seen in the last decade. FIRMS GASPING FOR LIQUIDITY Stretched working capital cycles are aggravating liquidity pressures on companies. Liquidity pressures are a source of stress for 16% of the 2,481 companies analysed. Large firms with operating income exceeding Rs 10 billion are impacted more acutely.

2

THE UGLY DEMAND SLOWDOWN HURTS THE MOST Industry and services, accounting for 86% of the GDP, will grow at a slower pace than last year. Two out of three sectors of the economy will experience lower revenue growth. Among sources of stress impacting corporates, demand slowdown remains the most important for nearly a fourth of the firms assessed by CRISIL, followed by stress on financing cost (interest cover) for a fifth. Larger firms (with operating income over Rs 1,000 crore) are facing more challenges due to higher level of indebtedness and increasing stress on financing cost. INDUSTRIAL GROWTH STAYS ANAEMIC Weak industrial growth means sectors that will suffer the most are infrastructure, cement, steel, power, construction and automobiles, where sales volumes will remain under pressure due to the relentless slowdown in the investment cycle and decelerating consumption. RAMIFICATIONS OF THE RUPEE ROIL India's huge current account deficit (CAD) will keep the rupee weak. It could rebound to 60/$ by March 2014 as CAD declines to 3.9%, but the currency will remain significantly depreciated compared with last fiscal. This will put upward pressure on inflation, fiscal deficit and input costs for corporates.

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4

The Economy

5

STATE OF THE NATION

CRISIL's macroeconomic forecast for 2013-14 2012-13

2013-14 (Jul '13 forecast)

2013-14 (Sep '13 forecast)

Total GDP (y-o-y %)

5.0*

5.5

4.8

Agriculture

1.9*

3.5

4.5

Industry

2.1*

3.5

1.0

Services

7.1*

6.9

6.5

WPI inflation (average)

7.3

5.3

6.2

Fiscal deficit (% of GDP)

4.9

5.2

5.2

10-year G-sec yield (March-end)

8.0

7.5-7.7

7.8-8.0

Current account deficit (% of GDP)

4.8

4.2

3.9

Rs per US$ (March-end)

54.5

56

60

* Central Statistical Organisation (CSO) provisional estimates Note: At this juncture, there is more downside than upside to our forecasts. If we get lucky and agriculture exceeds expectations and grows at 6%, the economy will grow at 5.2% this fiscal.

THE GOOD AGRICULTURE TO THE RESCUE Timely and well-distributed monsoon will offer a silver lining this year by lifting agricultural output substantially. Cumulative rainfall during July-August was 11% in excess of normal at the all-India level. Among the four regions, north-west, central and south received excess rains, whereas rainfall was deficient, or 29% below normal, only in the north-east. As a result, we have revised our agriculture growth forecast to 4.5% for this fiscal (up from 3.5%, its trend growth rate in the last 7 years, called in July). In the event of exceptionally high agriculture growth (say 6%) and its spillover into industry and services, GDP could even grow by 5.2%. Firing on one cylinder

FY14F

FY13P

Fy12

Fy11

Fy10

FY09

FY14F

Services FY13P

Fy12

Fy11

Fy10

FY09

FY14F

Industry

FY13P

Fy12

Fy11

FY09

FY14F

FY13P

Fy12

Fy11

Fy10

FY09

Fy10

Agriculture

Overall GDP

12.0 10.0 8.0 6.5

6.0 4.0

4.8

4.5

2.0 1.0 0.0

Source: CSO, CRISIL forecast

6

EXPORTERS GAIN, COMPETITIVENESS IMPROVES The weaker rupee will aid export sectors such as IT-ITES, textiles, readymade garments and cotton-yarn spinners, which source inputs domestically. A pick-up in exports will also ease the pressure on the current account. Equally importantly, a falling rupee improves India's currency competitiveness. Over the last four years, the rupee has been steadily losing ground against currencies of competing exporter economies. Since January this year, it has slid 20% versus the dollar, while the Chinese yuan has gained 1.6% and the Bangladeshi taka 2.4%.

THE BAD HEADLINE INFLATION TO FIRM UP TO 6.2%, INTEREST RATES TO RISE We had highlighted in July that there was an upside risk to inflation in the form of the weak rupee. That risk has now materialised. The rupee has depreciated nearly 20% in 2013 (as of September 5). WPI inflation rose sharply to 5.8% in July from 4.9% in June. The weak rupee will influence the import component (market-linked fuels, ferrous and non-ferrous metals and edible oil) of inflation. Due to continued political unrest in Egypt, and now the crisis in Syria, upward pressure on global crude oil prices will continue; in the first half of this fiscal, average crude oil prices are likely to be $105 per barrel compared with our earlier assumption of $102 per barrel. For the full fiscal year brent crude is expected to average US $105-110. Firm global crude oil plus weak rupee will drive up fuel inflation. Even though demand remains weak, firms will have to pass on to consumers at least some of the increased input costs arising from the weak rupee as well as other accumulated input cost build-up due to diesel and electricity price hikes. This will lead to an increase in core inflation, as reflected in both non-food manufacturing inflation and the CRISIL core inflation indicator. The latter has already risen to 3.7% in July from 3.6% in June. It is also important to note that despite a good monsoon, primary food inflation remains close to 10%. In view of these factors, we have revised upward the average WPI inflation forecast for this fiscal to 6.2% from 5.3%. Liquidity tightening measures undertaken by the Reserve Bank of India to limit the rupee's fall and contain its volatility have led to an increase in lending rates. As of September 2, 2013, private sector banks such as HDFC, ICICI, Axis, YES, DCB, Lakshmi Vilas and Kotak Mahindra had raised their base lending rates by 2035 basis points. In view of the already depressed investment climate, higher interest rates will only serve to inhibit the revival of investment. FISCAL DEFICIT TO SLIP TO 5.2% OF GDP The government's fiscal deficit in the first quarter was almost 50% of its budgeted level for the entire year, which is not a very heartening sign. What is encouraging, though, is that the government is making all the right noises on containing it to the targeted 4.8% levels. This commitment to fiscal consolidation implies that some cutback on government expenditure, especially capital expenditure, from the budgeted level, is likely for the year as a whole. However, the weak rupee is expected to increase under-recoveries, which will raise the petroleum subsidy burden of the government (Rs 770 billion compared with the earlier estimate of Rs 550 billion) while tax revenues may fall short of budgeted levels due to slowing growth. To ensure that there is no further loss of credibility with respect to its management of the economy, we expect the government to take all steps to ensure that fiscal deficit as a percentage of GDP will not breach the 5.2% mark. If revenue collection is adversely affected due to lower growth, the government is likely to curtail its expenditure significantly from budgeted levels rather than allow the fiscal deficit to slip.

4

7

STATE OF THE NATION

SERVICES GROWTH TO BE HIT BY INDUSTRIAL SLOWDOWN The negative effects of the industrial slowdown are likely to spill over into services sub-sectors such as trade, transport and banking.The linkages between industry and services have strengthened over time; industry/manufacturing is extending its weak performance to the services sector as well. Input-output data suggests that producing one unit of industrial output required 0.44 units of services in 2007-08 versus 0.36 units in 1988-89. The depreciation of the rupee and slowing growth are also resulting in an increase in the non-performing assets of banks, which are already suffering a decline in profitability on account of rising borrowing costs and mark-to-market losses on bond portfolios. Under these circumstances, we expect financial services growth to be lower than forecast earlier. Overall, the services sector is likely to grow by 6.5% this fiscal, which is slightly lower than our previous estimate of 6.9%.

THE UGLY GROWTH TO SLIP TO 4.8% THIS FISCAL Economic growth is projected to weaken further to 4.8% in 2013-14, the lowest since 2002-03 when it had logged 4.0%. Growth/demand slowdown (business risk) emerges as the most important vulnerability factor for India Inc. Net-net, there is neither going to be the V-shaped recovery seen after the Lehman crisis, nor a U-shaped one. It would more likely be an L-shaped one where the slowdown would continue through this fiscal. INDUSTRIAL GROWTH TO STAY TEPID, INVESTMENT CLIMATE WEAK Industrial recovery is paramount to the revival of the economy. But there is no such welcome sight on the near-term horizon. In the first quarter, industrial GDP showed a larger-than-expected slowdown to 0.2% compared with the corresponding period of the previous year. The investment climate remains weak the slowdown in demand made worse by lack of affordable credit. The mining sector, on the other hand, continues to suffer on account of regulatory hurdles in key states. And even if these issues were resolved immediately, no significant push to growth would be felt in 2013-14 due to its lagged impact. As a result, we now expect mining GDP to contract for the third consecutive year. The overall contraction in industrial activity will be sharper than what it was in each of the previous two years. Taking into account this slower-than-expected momentum, industrial output is now forecast to grow at a slower pace of 1% compared with 3.5% earlier. NO QUICK FIX FOR THE RUPEE Although there are signs that the market has overreacted in recent times, we believe that a large part of the problems engulfing the rupee arise from structural issues. Until these are adequately addressed, the rupee will continue to be weak and highly volatile in the near-to-medium term against major global currencies. Nevertheless, it is likely to strengthen to 60 per dollar by March 2014 from its current level of around 65-66, because the current account deficit (CAD) is likely to fall to 3.9% of GDP in 2013-14, compared with 4.8% last year. CAD is expected to correct significantly in the second half of the year due to a decline in non-oil imports, including gold. This will be supported by higher foreign capital inflows in the second half of the year if the steps announced by the government to attract $11 billion in capital inflows (via foreign borrowings by stateowned financial institutions and public sector oil companies, and measures to attract non-resident deposits) begin to yield fruit. In addition the US $50 billion bilateral swap agreement with Japan will also provide support to the rupee in times of stress.

8

Our revised forecast of CAD (3.9% of GDP this fiscal) is lower than our previous estimate of 4.2% mainly due to the expectation of a sharper slowdown in growth of non-oil imports, led by a nearly 28-30% fall in gold imports. Gold imports are likely to ease on the back of restriction on sale of gold bars and coins as well as a hike in customs duty on gold imports to 10%. We also expect capital and consumption goods imports to continue to moderate due to weak domestic demand. Although the CAD is now expected to be around $71-72 billion, total foreign capital inflows this year will be insufficient to cover it. As a result, the rupee will, on an average, be 12-14% weaker compared with last fiscal. The third quarter could also see high volatility in the rupee if the US Federal Reserve begins to taper its quantitative easing programme as expected. On the flip side, there could be some recovery in the currency around this time if CAD starts correcting and capital inflows begin to rise. The downward revision of the fiscal year-end forecast for the rupee to 60/$ from 56/$ earlier is due to the expectation of lower-than-earlier-anticipated foreign portfolio inflows.

Every rupee depreciation episode sets a new low Highest point in the fiscal

March-end of the fiscal

68.4*

INR/USD 70

60.0 #

54.4

51.2

54.2 44.7 Mar’11

47.6

50.5 45.1

40.0

Mar’10

47 44.6 Mar’07

51.0

46.3 44.6 Mar’06

43.2

46.5 43.8 Mar’05

47.5 43.4

49.1 47.5 Mar’03

Mar’04

48.9 48.8 Mar’02

46.6

43.6 43.6

40

42.4

45

42.6

50

46.9

55

52.1

60

57.2

65

*Till September 5, 2013 # CRISIL forecast

Mar’14

Mar’13

Mar’12

Mar’09

Mar’08

Mar’01

Mar’00

Mar’99

35

Source: CRISIL

Note: Each phase of rupee depreciation since 2008 has been followed by gradual appreciation, but the currency fails to come back to its previous level. In fact, the rupee is yet to recover from the fall it experienced in the aftermath of the Lehman crisis.

9

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10

The Sectors

11 7

STATE OF THE NATION

The sectoral picture shows a forking out of the economy with gainers from the rupee's depreciation on the one side and a significantly larger lot that is in pain on the other. An outlier is the telecom sector, which is seeing much-needed pricing power after years of cut-throat competition. So, as IT, pharmaceuticals, textiles and private oil players do well, public sector oil companies, construction, capital goods and commercial vehicle makers will remain under severe pressure. Car makers and realtors will have a rough ride too.

Sector

Parameter

Parameter change(%)

EBITDA margins

FY13

FY14P

FY13

FY14P

Export-linked sectors IT services

Revenue (USD)

10.0%

13-15%

24.2%

26.7-27.2%

Pharmaceuticals

Revenue (Rs)

24.0%

20-22%

21.8%

22-24%

Revenue (USD)

-6.0%

4-5%

11.1%

13%

Readymade garments* - Exports - Domestic

Revenue (Rs)

4.0%

5%

14.5%

16.5-17%

Cotton yarn

Revenue (Rs)

24.3%

20-22%

15.3%

17-18%

Two-wheelers

Volume (Nos)

2.9%

4-6%

9.2%

9-9.5%

Commercial Vehicles

Volume (Nos)

-2%

-8 to -10%

4.4%

2-2.5%

MHCV

Volume (Nos)

-26%

-10 to -15%

n.a.

n.a.

LCV

Volume (Nos)

16%

-8 to -10%

n.a.

n.a.

Bus

Volume (Nos)

-4%

1 to -1%

n.a.

n.a.

Cars & UVs

Volume (Nos)

2.0%

-8 to -11%

n.a.

n.a.

Tractors #

Volume (Nos)

-2.0%

16-18%

12.7%

13.5-14%

Auto components

Revenue (Rs)

2-4%

0 to -2%

12.3%

11.7-12%

Construction

Revenue (Rs)

6.8%

2-4%

12.8%

12-12.5%

Cement

Volume (MT)

3.0%

2.5%

22.3%

19-19.5%

Power

Million units (kwh)

6.5%

4.70%

n.a.

n.a.

Automobile sectors

Infrastructure-linked sectors

Volume (MTPA)

4.6%

2-3%

17.0%

15-16%

Refining & marketing

Volumes (MTPA)

4.7%

2.4%

n.a.

n.a.

Telecom

Average revenue per user (Rs)

4.0%

7-9%

26.2%

26.7-27.2%

Hotels

Revenue (Rs)

6.0%

3-4%

18.8%

16-17%

Real estate

New home sales (units)

-5%

-6%

n.a.

n.a.

Steel

Other sectors

Note: * for calendar years 2012 and 2013 # represents PBIT margins

12

Source: CRISIL

THE GOOD EXPORTER ECONOMY ON A GOOD WICKET Export-oriented sectors are expected to see higher volumes as well as improved realisations. Volumes are expected to increase in sectors such as IT and textiles due to the improvement in economic outlook in key markets such as the US. Along with pharmaceuticals, these sectors are expected to witness higher realisations in rupee terms on account of currency depreciation. IT TO SEE FASTER REVENUE GROWTH The IT sector is expected to see faster dollar revenue growth (around 14% compared with 10% in FY13) on the back of an improvement in the demand outlook in the US and Europe. Despite a 1-2% decline in billing rates and higher onsite hiring, earnings before interest, tax, depreciation and amortisation (EBITDA) margins are expected to expand close to 250-300 bps, led by a weak rupee (expected to average 62/$ compared with 54/$ in FY13). PATENT CURBS IN PHARMA The pharmaceutical sector, where exports contribute close to 60% of revenues, is expected to see slower dollar revenue growth (around 12% compared with nearly 18% in FY13) due to fewer drugs going off patent. Growth of domestic formulations is expected to be steady at nearly 12%, despite some pressure on realisations because of the new drug-pricing policy. Rupee revenues could grow 20-22% compared with 24% last year. EBITDA margins will expand by 100-150 bps for large players with significant formulation exports to regulated markets in the US and Europe, and by 75-125 bps for mid-sized players with higher exposure to semi-regulated markets. Bulk drug exporters (with close to 90% export revenues) are likely to see the highest EBITDA margin expansion (close to 150-200 bps). CLOTHIERS ON A GOOD RUN The readymade garments sector is expected to see dollar revenue growth of close to 4-5% compared with a decline of nearly 6% in FY13, led by improved demand in the US. Domestic revenues are expected to grow nearly 5% on the back of buoyant rural demand, driven by higher incomes due to the good monsoon. EBITDA margins of exporters are likely to rise close to 200 bps on the rupee fall, while those of domestic-focused companies will improve 200-250 bps because the excise duty cut effected in March 2013 is unlikely to be passed on to consumers. CHINA LIFT FOR COTTON YARN SPINNERS Cotton yarn spinners could see volume growth of nearly 10% after an almost 13% increase in FY13. This will be driven by continued healthy exports to China – expected to grow about 30% in FY14. EBITDA margins can expand 200 bps driven by the nearly 10% increase in cotton yarn prices (due to strong export demand and a weak rupee). TRACTORS, TWO-WHEELERS CRUISE The tractors segment should see a healthy 16% growth in volumes on account of good monsoon. EBITDA margins can improve nearly 100 bps led by an increase in capacity utilisation. Two-wheeler segment volumes are likely to rise by a modest 4-6% on the back of rural demand, while urban demand could stay weak. EBITDA margins are expected to remain flat. MELODIOUS RING FOR TELECOM The telecom sector is expected to see a healthy growth of 7-9% in average revenue per user (ARPU) in FY14, led by waning competitive intensity, which will improve the industry's pricing power. EBITDA margins are expected to rise 50-100 bps on account of improved realisations, despite rising diesel costs.

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STATE OF THE NATION

GUSHER FOR PRIVATE OIL PRODUCERS Private sector oil producers, led by Cairn India, could see strong growth in realisations on the back of the rupee's fall and high crude oil prices (Brent crude is expected to average $105-110 per barrel this fiscal). However, due to continued high under-recoveries, the subsidy-sharing burden of public sector oil producers such as ONGC and Oil India is expected to remain high at nearly 50% of total under-recoveries, which will offset realisation benefits to a large extent. Refining companies will do well because the weak rupee will boost realisations (domestic realisations are based on import parity, whereas export realisations are in dollar terms). Gross refining margins would remain a healthy $6-7 per barrel this fiscal.

THE BAD FEEBLE GROWTH IN POWER DEMAND Power sector demand is seen growing a modest 4.7% due to weak industrial demand and offtake risk on account of poor health of state discoms. The plant load factors of thermal plants are expected to decline 200 bps to 68%, led by weak demand and limited fuel availability for some plants. High interest costs and high imported coal costs due to the depreciation of the rupee will result in continued pressure on profitability. CEMENT CRACKING UP The cement sector is expected to see muted volume growth of close to 2.5%, despite improved rural demand and some pre-election government spending. EBITDA margins could decline 300-350 bps on account of muted realisations, higher fuel and freight costs. STEEL SUBDUED Steel sector volumes are expected to grow a muted 2-3% due to weak demand from construction, automobiles and consumer durables sectors. Capacity utilisation rates are expected to fall by around 1000 bps as over 15 million tonnes of capacity is likely to come on stream in the current year. Indian manufacturers are unlikely to benefit from a weaker rupee as fragile domestic demand and high inventory levels will constrain pricing power. EBITDA margins of most companies could decline 100-200 bps. High interest outgo (due to leveraged balance sheet of most companies in the sector) will exert further pressure on net profit margin. OIL MARKETERS ON SKID ROW Public sector oil marketing companies continue to be saddled with high under-recoveries (estimated Rs 1.41.5 trillion for this fiscal) despite the hike in regulated fuel prices. The profitability of these companies is, thus, contingent upon the government's decision on subsidy sharing. Working capital is expected to remain strained due to delayed subsidy reimbursements. Overall growth in sale of petroleum products is expected to be weak (around 2.4% compared with 4.7% in FY13) due to rising prices and weak economic outlook. Diesel, which accounts for close to 45% of overall domestic petroleum product consumption, is expected to grow at just 2% compared with nearly 5-6% in FY13, due to rising prices and slowing economic activity. AUTO COMPONENTS IN SLOW LANE Auto component segment revenues are expected decline by close to 2% after a 2-4% growth in FY13, led primarily by a drop in sales to original equipment manufacturers (OEMs). EBITDA margins are expected to fall nearly 50 bps on account of pressure on volumes and aggressive bargaining by OEMs.

14

THE UGLY CONSTRUCTION CAUGHT IN LIQUIDITY PINCER Construction sector revenues will grow at a tepid 2-4%, led by the continued decline in fresh order inflows and slower execution of existing orders due to policy bottlenecks, high interest costs, leveraged balance sheets of many project developers and slowing demand. Profitability is expected to remain under pressure with EBITDA margins expected to decline by around 50 bps. Continued high working capital requirements and high interest costs are expected to result in severe pressure on bottomline. DOUBLE BLOW FOR REALTORS For the real estate sector, the economic slowdown and high capital values have dealt a double blow to affordability by impacting both income and cost. Demand for residential real estate across the 10 major cities of India is expected to decline around 6% on a y-o-y basis in calendar 2013 and a further 4% in calendar 2014. Despite declining transaction volumes, capital values have held up so far. In future, however, a continued decline in demand and rising inventories will force developers to reduce capital values. CRISIL expects a 5% correction by December 2013 and a further decline of 6-7% in calendar 2014. Mumbai and the National Capital Region will see the maximum decline in demand (8% and 10%, respectively) in 2013 over calendar 2012. Leveraged balance sheet and constraints on funding will exacerbate the effect of demand slowdown. TRUCK MAKERS HIT A SNARL For commercial vehicle manufacturers, weak freight movement and continued slowdown in infrastructurerelated demand is likely to result in an 8-10% decline in total sales volumes, after a decline of nearly 2% in FY13. Medium to heavy commercial vehicle volumes are expected to slip 10-15% on the back of a 26% fall in FY13. Light commercial vehicle volumes are expected to drop 8-10% after growing at a healthy 16% in FY13 due to slowing freight movement and weak fleet utilisation rates. EBITDA margins are expected to decline over 200 bps on a very low base of 4.4% in FY13. CARS, UTILITY VEHICLES IN REVERSE GEAR Cars & utility vehicles segment volumes are expected to decrease 8-11% on account of weak consumer sentiment due to growing uncertainty about income growth, high interest rates, rising fuel prices and increase in excise duty on utility vehicles.

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16

How Vulnerable is India Inc?

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STATE OF THE NATION

In difficult times, how does one assess corporate vulnerability? By weighing them on stress factors. We zeroed in on five – demand pressure, liquidity and working capital challenges, extent of indebtedness, ability to service debt (interest cover), and foreign currency volatility, and studied their effect on 2,481 firms to arrive at our conclusion. Size-wise (operating income) proportion of 2,481 firms assessed by CRISIL Greater than Rs 10 bn 12%

Between Rs 2.5 bn and Rs 10 bn 27%

Less than Rs 2.5 bn 61%

Source: CRISIL

But why these firms? Because they are the ones CRISIL has rated as investment grade (BBB- or above). In terms of financial footprint, they account for about 32% of banking credit to corporates and 82% of CRISILrated debt. Sector-wise proportion of 2,481 firms assessed by CRISIL Diversified Energy Commercial & professional services Technology, hardware & equipment Media Software & services Fertilisers & agricultural chemicals Transportation Building products and construction materials Education Packaging and paper products Gems & jewellery Real estate Chemicals Health care & pharmaceuticals Textiles Trading Metals & mining Automobiles & components Capital goods Infrastructure Consumption-related 0

50

100

150

200

250

300

350

400

450

Source: CRISIL Note: Consumption-related sectors include companies in industries such as food and beverages, FMCG, apparel, consumer durables, edible oil, home furnishing, leather and office equipment.

18

These have turnovers as low as Rs 6 crore, while the largest one has Rs 465,000 crore. They traverse more than 20 sectors with no sector accounting for more than 16% of the total firms. This diversity is what makes the study the most comprehensive done to date on the vulnerability of India Inc. A note is in order: this study does not cover 10,000 firms rated sub-investment grade (BB and lower). Sure, they would display higher vulnerability, but their financial footprint is just 18% of the total CRISIL-rated debt.

THE GOOD FOREX VOLATILITY IMPACTING VERY SMALL PORTION OF CRISIL-RATED FIRMS Despite a significant depreciation of the rupee over the last few months, only 6% of the 2,481 firms are displaying high vulnerability to foreign currency volatility. Notably, the study does not include some of the major corporate houses that have large foreign currency exposures such as Essar, GMR, GVK, JSW, Jaypee and Videocon. CRISIL does not have ratings on most companies from these groups and hence, our analysis does not incorporate them. PHARMA, SOFTWARE AMONG LEAST IMPACTED Only 8% of the pharmaceuticals and healthcare firms and 14% in software show high vulnerability to two or more sources of stress.

THE BAD LIQUIDITY PRESSURES IMPACTING A SIXTH OF FIRMS While liquidity pressures present a high source of vulnerability for 16% of the 2,481 firms, they are more acute for the larger firms (operating income in excess of Rs 1,000 crore). The slowing economy has led to a piling up of inventory and receivables, resulting in liquidity stress for slightly over a fourth of the big firms. It has also engendered refinancing pressures for firms where net cash accruals are likely to be insufficient to service term-debt repayments for about a fifth of the larger-sized firms. METALS & MINING, FERTILISERS, AGROCHEM IN LINE OF FIRE As many as 23% of firms in the metals and mining industry show vulnerability to two or more sources of stress, primarily emanating from slowing demand. Around 19% in the fertilisers and agro-chemicals industry show vulnerability to two or more sources of stress, chief of which is the stretched liquidity.

THE UGLY DEMAND SLOWDOWN MOST IMPORTANT SOURCE OF STRESS Almost a quarter of the firms assessed by CRISIL show high vulnerability to the slowdown in demand. On the other hand, stress on operating profitability and financing cost, which lead to stress on interest cover, affect a fifth. LARGER FIRMS HAVE TO BEAR MORE As many as 36% of the larger firms (with operating income of more than Rs 1,000 crore) have displayed vulnerability to two or more sources of stress, chief of them being challenges due to higher level of indebtedness and increasing stress on operating profitability and financing cost (interest coverage).

19

STATE OF THE NATION

GREATER VULNERABILITY FOR REALTY, INFRA, AUTO, TRANSPORT, CAPITAL GOODS The proportion of firms from these sectors that have displayed vulnerability to at least two sources of stress ranges from 25% to 36%. While high indebtedness, stretched liquidity and pressure on interest cover are impacting the real estate and infrastructure adversely, demand pressures and consequent pressures on liquidity are impacting auto components and transportation. Capital goods companies are plagued by demand slowdown on account of lack of investment demand in the economy, which is also impacting their interest cover adversely. Size-wise (operating income) break-up of firms facing high vulnerability in 2 or more factors 100%

80%

34% 49%

52%

60% 30% 40% 33%

28%

18%

20%

Less than Rs 2.5 bn

Between Rs 2.5 bn and Rs 10 bn

20%

36%

0%

Two or more stress factors

Greater than Rs 10 bn

Only one stress factor

None

Source: CRISIL

20

Key Findings from an analysis of 2,481 firms rated investment grade and above by CRISIL

21

STATE OF THE NATION

SLOWING DEMAND IS THE BIGGEST STRESS, FOREX THE SMALLEST Source-wise vulnerability assessment of firms Assessment on each source of stress 25% of the firms have been assessed as displaying 'high' vulnerability to demand slowdown, whereas only 6% of the firms are identified as being highly vulnerable to forex stress

High

Demand assessment

Forex risk

Liquidity risk

TOL/TNW

Interest cover

620

160

402

386

488

1,084

192

1,393

87

269

Low

777

2,129

686

2,008

1,724

Total

2,481

2,481

2,481

2,481

2,481

Medium

% of total Demand assessment

Forex risk

Liquidity risk

TOL/TNW

Interest cover

High

25%

6%

16%

16%

20%

Medium

44%

8%

56%

4%

11%

Low

31%

86%

28%

81%

69%

Total

100%

100%

100%

100%

100% Source: CRISIL

Based on the framework of vulnerability analysis and the methodology followed, CRISIL found that demand slowdown is the biggest source of vulnerability, while foreign exchange is the smallest. Almost a fourth of the 2,481 companies show high vulnerability to slowing demand, while financing cost (interest cover) is a high vulnerability issue for a fifth. Despite the huge depreciation in the rupee over the last few months, only 6% of the firms were identified as being highly vulnerable due to forex exposure, with the primary stress emanating from forex-denominated debt. Our analysis indicates that companies which had significant forex debt in their books either have a 'natural hedge' through high level of forex-denominated earnings or their balance sheets are strong enough to mitigate the stress emanating due to the sharp currency depreciation. For the firms analysed, some of the key conclusions are: n

Aggregate forex-denominated debt stood at about $100 billion as on March 31, 2013, which is about 50% of the total corporate forex debt in India.

n

The debt is concentrated in a few firms, with the top 1% accounting for more than 85% of it.

n

Total unhedged forex exposure was estimated at about $98 billion after considering forex denominated debt and netting of natural hedge available due to forex-denominated trade receivables/payables and active hedges.

The analysis covers only half of the total corporate forex debt in the country, and does not include some of the major corporate houses that have large foreign currency exposures, such as Essar, GMR, GVK, JSW, Jaypee and Videocon. CRISIL does not have ratings on most companies from these groups and hence our vulnerability analysis does not incorporate these companies.

22

21% FIRMS IMPACTED BY MULTIPLE SOURCES OF STRESS Proportion of firms facing high stress in 2 or more factors 100% 90% 80%

48% 48%

None 70% 60% 50% 40%

Only one stress factor

30%

31% 31%

20% Two or more stress factors

10%

21%

0% Source: CRISIL

The analysis revealed that about 21% of the firms have two or more sources of stress assessed in the highvulnerability category. One can further delve into the type of firms that were assessed, based on their size (operating income) or the industry to which they belonged. LARGER COMPANIES FACING MORE CHALLENGES THAN SMALLER ONES Size-wise break-up of firms facing high vulnerability on different stress factors Larger firms Smaller firms 26%

25%

Larger firms Smaller firms

Demand stress

18%

34%

26%

Ability to service debt (interest cover)

13%

15%

27%

12% Extent of indebtedness

7%

11%

Capex/ networth

Liquidity stress

34%

22% GCA as days of op income

21%

11% NCA/CPLTD

6%

Forex stress

Source: CRISIL

Larger firms (with operating income of over Rs 1,000 crore) seem to be facing more challenges than the smaller ones (with operating income of less than Rs 250 crore). Around 36% of the larger firms have two or more sources of stress compared with only 18% for the smaller firms.

23

STATE OF THE NATION

For the larger firms, high level of indebtedness and increasing stress on financing cost (interest cover) were the two major sources of vulnerability, each impacting around 34% of the firms. These were closely followed by stretched liquidity, impacting around 27% of the firms. On the other hand, slowing demand was the single major source of vulnerability impacting the credit profile of smaller firms, with 26% scoring a 'high' on this factor. This was followed by interest cover and liquidity vulnerabilities, with 18% and 15% of the firms, respectively, scoring a 'high'. Extended working capital cycle is the major reason for the exaggerated liquidity vulnerability that was identified as the third major source for both large and small firms. Around 26% of the larger firms and around 22% of the smaller ones scored a 'high' on gross current asset (GCA) days. The increase was primarily led by a stretch in receivables. REALTY, INFRA, AUTO, TRANSPORT, CAP GOODS AMONG WORST-HIT Sectoral break-up of firms facing vulnerability in 2 or more stress factors Education Health care & pharmaceuticals Packaging and paper products Software & services Chemicals Textiles Consumption-related

Building products and construction Fertilisers & agricultural chemicals Metals & mining Gems & jewellery Capital goods Transportation Automobiles & components Infrastructure Real estate 0%

5%

10%

15%

20%

25%

30%

35%

40%

Source: CRISIL

The real estate sector has the highest proportion of firms (36%) where at least two sources of stress have scored a 'high', followed by infrastructure (30%), automobiles (28%), transportation (25%) and capital goods (24%). On the other hand, education (3%), healthcare and pharmaceuticals (8%) have the least proportion of firms where at least two sources of stress have been scored 'high'.

24

Methodology, Other Insights

25

STATE OF THE NATION

Annexure 1 Vulnerability analysis THE 5 YARDSTICKS CRISIL analysed the companies based on five sources of stress and classified their vulnerability into high, medium and low. The sources of stress are: 1 2 3 4 5

Demand pressures Liquidity and working capital challenges Extent of indebtedness (total outside liabilities/ tangible networth) Ability to service debt (interest cover), and Foreign currency volatility

DEMAND PRESSURES While classifying the firm's vulnerability to demand pressures, CRISIL has assessed the expected revenue growth in relation to the recent past (2-3 years). Firms whose performance is expected to be materially lower, flat or witness a decline in revenue growth are classified as displaying 'high' vulnerability to demand pressures, while firms which are likely to display similar or better growth are classified as displaying 'low' vulnerability. LIQUIDITY PRESSURES Liquidity assessment was based on three parameters: 1 2 3

Net cash accruals vis-à-vis term debt repayments (NCATDR) Gross current assets (GCA; adjusted for surplus cash) Planned capital expenditure (Capex) vis-à-vis networth

NCATDR Indicates the buffer in a firm's cash accruals in relation to the upcoming term debt repayments; higher the buffer, lower is the firm's vulnerability to liquidity pressures. GCA Slowdown adversely impacts a firm's sales, which results in a piling-up of inventory or stretch in receivables and thus increase in the GCA. Higher the GCA, longer is the cash conversion cycle and hence greater is the firm's vulnerability to liquidity pressures. CAPEX VIS-À-VIS NET WORTH In the current scenario of tight liquidity, firms will find it tough to raise funds both debt as well as equity. Hence, firms with committed capex requirements will rely heavily on internal accruals to fund the capex, which could strain its liquidity. Higher a firm's committed capex, greater is its vulnerability to liquidity pressures. EXTENT OF INDEBTEDNESS This is reflected in the ratio of total outside liabilities as a proportion of tangible networth (TOL/TNW). Higher the ratio, higher is the firm's external indebtedness, which increases the vulnerability of the firm's financial risk profile, given the weak economic environment.

26

ABILITY TO SERVICE DEBT (INTEREST COVER) Interest cover is an indicator of the buffer available in the company's operating profit in relation to the servicing of interest and finance costs. Lower the interest cover, lower is the buffer and hence higher is the firm's vulnerability to profitability pressures and to increase in financing costs. FOREIGN CURRENCY VOLATILITY CRISIL has created a comprehensive framework, which includes forex-denominated debt, receivables and payables, as well as forex derivative positions, to arrive at a firm's overall forex exposure. We have computed value at risk (VaR) by using a forex variation of 10% for short-term exposures and 20% for longterm exposures. This VaR is compared to the firm's net profit and networth. Higher the VaR in relation to the firm's PAT and networth, higher is its vulnerability to forex variations.

27

STATE OF THE NATION

Annexure 2 Other insights from vulnerability analysis No. of firms that have scored a ‘high’ under different sources of stress based on size of operating income Larger firms are more vulnerable than smaller ones – about 36% of firms with revenue greater than Rs 1,000 crore have two or more of the factors scored in the high-risk category

Less than Rs 250 crore

Between Rs 250-1,000 crore

Greater than Rs 1,000 crore

Condition

Count

Percentage

Condition

Count

Percentage

Condition

Count

>3

18

1%

>3

9

1%

>3

19

6%

3

67

4%

3

35

5%

3

37

12%

2

192

13%

2

92

14%

2

54

18%

1

498

33%

1

185

28%

1

93

30%

0

733

49%

0

344

52%

0

105

34%

Total

1,508

100%

Total

665

100%

Total

308

100%

>=2

277

18%

>=2

136

20%

>=2

110

36%

Percentage

Source: CRISIL

Break-up of firms based on size of operating income and sources of stress Less than Rs 250 crore

For larger firms, level of indebtedness (TOL/TNW) is the major source of stress – vulnerability from this was 'high' for 34% of the larger firms. Due to high leverage, pressure on financing cost (interest coverage) is another major source of stress impacting similar proportion of firms

Demand assessment

Forex stress

Liquidity stress

TOL/TNW

Interest cover

High

391

89

219

183

274

Medium

660

99

904

44

143

Low

457

1,320

385

1,281

1,091

Total

1,508

1,508

1,508

1,508

1,508

High%

26%

6%

15%

12%

18%

Between Rs 250-1,000 crore Demand assessment

Forex stress

Liquidity stress

TOL/TNW

Interest cover

High

153

50

100

99

109

Medium

310

56

341

29

86

Low

202

559

224

537

470

Total

665

665

665

665

665

High%

23%

8%

15%

15%

16%

Greater than Rs 1,000 crore Demand assessment

Forex stress

Liquidity stress

TOL/TNW

Interest cover

High

76

21

83

104

105

Medium

114

37

148

14

40

Low

118

250

77

190

163

Total

308

308

308

308

308

High%

25%

7%

27%

34%

34% Source: CRISIL

28

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29

STATE OF THE NATION

Sector-wise break-up of firms displaying 'high' vulnerability to different sources of stress

Sectors such as real estate (36%), infrastructure(30 %) and automobiles (28%) have highest proportion of firms where they have displayed 'high' vulnerability to at least two sources of stress

30

Automobiles & components

Building products and construction materials

>3

5

3

15

2

Capital goods

Chemicals

Commercial & professional services

0

13

3

2

20

3

28

11

39

1

49

26

0

77

Total Proportion of firms displaying 'high' vulnerability to at least two sources of stress as % of total

Consumption related

Diversified

Education

Energy

0

4

1

0

0

1

17

1

0

3

12

1

46

0

2

3

109

24

11

95

6

18

6

30

115

80

14

223

5

56

8

174

69

296

122

27

385

13

76

20

28%

19%

24%

15%

7%

17%

15%

3%

30%

Infrastructure

Media

Metals & mining

Packaging and paper products

Real estate

Software & services

Technology hardware & equipment

Trading

Transportation

Gems & jewellery

Textiles

0

11

0

1

1

0

0

1

4

0

0

2

0

31

2

8

2

8

0

1

7

2

4

7

4

10

49

8

26

7

21

5

2

25

10

15

14

Fertilizers & agricultural chemicals

Healthcare & pharmaceuticals

0 5

8

28

127

8

54

22

34

8

15

52

14

23

39

30

95

84

15

61

46

17

22

14

52

22

38

78

47

133

302

33

150

78

80

35

33

140

48

80

140

19%

8%

30%

30%

23%

13%

36%

14%

12%

26%

25%

24%

16%

Source: CRISIL

31

STATE OF THE NATION

Notes

32

Notes

33

STATE OF THE NATION

Notes

34

About CRISIL Limited CRISIL is a global analytical company providing ratings, research, and risk and policy advisory services. We are India's leading ratings agency. We are also the foremost provider of high-end research to the world's largest banks and leading corporations. With sustainable competitive advantage arising from our strong brand, unmatched credibility, market leadership across businesses, and large customer base, we deliver analysis, opinions, and solutions that make markets function better. Our defining trait is our ability to convert data and information into expert judgements and forecasts across a wide range of domains, with deep expertise and complete objectivity. At the core of our credibility, built up assiduously over the years, are our values: Integrity, Independence, Analytical Rigour, Commitment and Innovation. CRISIL's majority shareholder is Standard and Poor's(S&P). Standard & Poor's, a part of McGraw Hill Financial, is the world's foremost provider of credit ratings. CRISIL Privacy Notice CRISIL respects your privacy. We use your contact information, such as your name, address, and email id, to fulfil your request and service your account and to provide you with additional information from CRISIL and other parts of McGraw Hill Financial you may find of interest. For further information, or to let us know your preferences with respect to receiving marketing materials, please visit www.crisil.com/privacy. You can view McGraw Hill Financial's Customer Privacy Policy at http://www.mhfi.com/privacy. Last updated: May, 2013

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Authored by

Roopa Kudva

Arun Panicker

Managing Director & CEO CRISIL Ltd

Chief Analytical Officer CRISIL Ratings

Mukesh Agarwal

Dharmakirti Joshi

President CRISIL Research

Chief Economist CRISIL Ltd

Prasad Koparkar

Somasekhar Vemuri

Senior Director CRISIL Research

Director CRISIL Ratings

CRISIL Limited CRISIL House, Central Avenue Hiranandani Business Park, Powai, Mumbai - 400 076. India Phone: +91 22 3342 3000 | Fax: +91 22 3342 3001 www.crisil.com

Raj Nambisan Director - Editorial CRISIL Ltd