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Corporate India is expected to witness a slight sequential improvement in credit metrics in the third quarter of fiscal year 2023-24 as interest coverage ratio is estimated to increase to 4.5-5 times in Q3FY24 from 4.5 times in Q2FY24, according to rating agency ICRA. It is due to improved earnings of India Inc, on the back of continuing, but moderating tailwinds from commodity prices and seasonally strong demand in the recently concluded festive season.
Interest coverage ratio is a debt as well as profitability ratio which is used to measure a company’s capacity to pay interest on its outstanding debt. It is calculated by dividing a company’s earnings before interest and taxes by its interest expense during a particular period.
According to Kinjal Shah of ICRA, steady demand enabled 1.6% and 0.1% year-over-year and sequential revenue growth, respectively, for India companies in Q2FY24. However, the revenue growth on yearly basis was partially capped due to declining realization levels as input costs dropped for most sectors. “While consumer and infrastructure-facing sectors supported revenue expansion, commodity-linked sectors saw contraction in revenue due to price corrections after historically high levels recently,” Shah said.
Shah added that while revenue in third quarter of the current fiscal will continue to grow, partly helped by festive demand, sustaining the growth momentum remains uncertain due to global economic uncertainties. The overall impact of food inflation on rural demand and related sectors also bears monitoring.
Additionally, ongoing geopolitical tensions could adversely influence demand sentiment, especially for export-oriented sectors, according to the rating agency. Furthermore, as the base effect catches up, the pace of growth will likely remain subdued, as already evident in recent quarters.
Improvement in operating margin
ICRA’s analysis of 601 listed non-financial companies showed operating profit margins improved as expected in Q2FY24, rising 398 basis points year-over-year and 64 basis points quarter-over-quarter, aided largely by softening commodity prices. However, though input costs eased in recent months, they continue to be still elevated historically, and as a result margins are yet to return to peak levels.
The rating agency said that better earnings along with the pause in rate hikes by the MPC, thereby capping finance cost increases, led to higher interest coverage of 4.5 times in Q2FY24 compared to 3.9 times in Q2FY23 for ICRA’s sample. However, it was broadly steady sequentially. ICRA projects interest coverage ratio to increase to 4.5-5.0 times in Q3FY24 based on the expected earnings revival and rate hike pause, although inflation trends remain an ongoing concern.
Further, the rating agency noted that the revenue growth momentum is likely to slow down, with year-on-year revenue growth estimated at 2-4% for Q3FY24 as well as in the second half of FY24.