A sparkling balance sheet that fails to deliver

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The financial health of the Indian non-financial corporate sector was awesome, to put it mildly, by the end of the last financial year that ended in March 2019. But, its faith on the future was abysmally dismal. We had described such a condition for the year ended March 2018 as well. A year later, these contradicting conditions have only accentuated.

During the year ended March 2019, Indian non-financial corporate sector saw a big upswing in sales growth, profits growth and profitability. The sales growth came from both, volume growth and price growth, the profits growth was at every level of profits – from operating profits through net profits and the profitability improvement was both on sales margins and returns on investments. This super performance came through better utilisation of assets and better working capital cycle management. The sector achieved all this without increasing leverage.

In spite of all this, the corporate sector refused to invest enthusiastically to build capacities for the future. It preferred to take the money out in dividends and a good part of their financial investments were into debt instruments and not equities. Apparently, they had no confidence in their own future and likewise, on the future of other companies.

The balance sheet of non-financial corporate sector reflected a lender’s dream ratios. But, companies were less than enthusiastic to borrow. This is because they were even less enthusiastic to invest.

As of March 2019, the debt: equity ratio of the non-financial corporate sector was at its lowest in three decades. At 0.7 it was 19 basis points lower than its historical low of 0.91 recorded in 2007-08. Total outside liabilities (which include current liabilities besides borrowings) to tangible net worth was also at a historical low of 1.52. Evidently, the Indian corporate sector is highly under-leveraged compared to its historical record.

Aggregate interest cover was a handsome 3.57 in the year ended March 2019. It was 2.2 in the year ended March 2018 and 2.1 before that. Thus, companies could comfortably service their debts. The interest cover at 3.6 in 2018-19 was the best in the past eleven years.

These are ratios derived from the audited financial statements of over seven thousand companies for the year ended March 2019. This large sample of companies is a fairly representative sample of the corporate sector as a whole. The sample of companies for earlier years is larger at over 20,000. Aggregate data from these tell us that the corporate sector as a whole was never seriously financially stressed. The aggregate debt: equity ratio never crossed 1.5 and the aggregate interest cover never dropped below 1.5.

And, even against the backdrop of a reasonably conservative balance sheet, the corporate sector appears in its best health today. Yet, it refuses to invest.

The aggregate ratios are a fair measure of the overall health of the non-financial corporate sector. The mean interest cover was 3.6 and the median was 3.7. More than half the companies were more than just good to borrow. The median interest cover was never this high.

The interest cover at the 75th percentile was 14.6. This is way above the cover of 10 recorded in 2017-18, which in itself was a record.

The lower end of the interest cover spectrum is also very good. Interest cover at the 25th percentile was 1.54. This means that less than 25 percent of the companies could be classified as vulnerable to debt default.

In spite of such a sparkling balance sheet, companies are unwilling to invest. Aggregate growth in net fixed assets in 2018-19 at 5.5 percent was near the 3-decade lowest growth rate.

Interest cover for all the top five deciles by size of company was over 2 in the year ended March 2019. The debt: equity ratio for all of them was less than 1 except decile 3 where it was 1.05. Yet, all deciles saw their lowest (or near lowest) growth in net fixed assets in the year.

Clearly, companies are not not-investing because of a poor balance sheet. In fact, they are not investing in spite of the best balance sheet that one could have imagined. So, the reasons for their lack of enthusiasm has to be found elsewhere.

The few signs that could be a reflection of some distress are not entirely convincing. For example, borrowing through commercial paper, which is necessarily a short-term instrument, increased by 52 percent in 2018-19. Reliance on commercial paper has been increasing but, it is still small. It accounted for 5 percent of total outstanding borrowing as of March 2019. In 2011-12, it accounted for less than one percent. Inter-corporate loans grew by 18 percent while total borrowing grew by just 8.6 percent and bank borrowing grew by 6 percent. Borrowing from promoters and directors, which like inter-corporate borrowing is mostly unsecured, increased by 10 percent.

Interestingly, the corporate sector did not take much recourse to debentures and bonds in 2018-19. These grew by only 1 percent in the year although they have been growing at 9 percent in the preceding two years and at 20 percent per annum earlier.

So, there are signs of an increase in unsecured borrowing and a fall in the reliance on corporate bonds. Possibly, companies are shy to invest and shy to borrow from market instruments. What is the corporate sector hiding behind its sparkling balance sheet?

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