October 10, 2017 I Economics. Credit Quality: H1 FY18

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1 Credit Quality: H1 FY18 Contact: Smita Rajpurkar Associate Director Kavita Chacko Sr. Economist - Associate Director kavita.chacko@careratings.com Dr. Rucha Ranadive Associate Economist rucha-ranadive@careratings.com Mradul Mishra (Media Contact) mradul.mishra@careratings.com October 10, 2017 I Economics The movement of credit ratings of the entities rated by CARE Ratings in the first half of the ongoing fiscal (H1 FY18) illustrates the prevalence of the overall stability in the credit quality of these entities. There has been a higher number of upgrades compared with downgrades in H1 FY18, reflecting the strengthening credit quality of the rated entities. Further, the large proportion of reaffirmations of credit ratings during the first six months of the current fiscal is indicative of the high degree of stability in credit quality. Credit Rating and Modified Credit Ratio (MCR) The changes in credit rating of the rated entities reflect improvement, stability or weakness in the financial health of these entities. These changes are captured in CARE s Modified Credit Ratio (MCR), and the movement of the MCR helps measure mobility in ratings. It is thus reflective of the changes in credit quality in the system. CARE s Modified Credit Ratio (MCR) is defined as the ratio of (upgrades and reaffirmations) to (downgrades and reaffirmations). An increase in MCR denotes an increase in upgrades vis-à-vis downgrades, whereas a decrease in MCR shows the reverse. In other words, an increase in the MCR implies an improving credit quality of the rated entities. An MCR closer to one indicates higher stability in the ratings, with larger proportion of reaffirmations. The changes in credit quality as measured by MCR for 7 years has been analyzed and summarized here. Given the large quantum and diverse set of entities rated by CARE Ratings, the cumulative findings can be treated as being representative of the overall system. Exhibit 1 captures the movement in MCR in the first half (H1) of the fiscal years FY The MCR in H1 FY18 at 1.03, indicates the stability in credit quality. It excludes cases in the category of Issuers not cooperating. Disclaimer: This report is prepared by CARE Ratings Ltd. CARE Ratings has taken utmost care to ensure accuracy and objectivity while developing this report based on information available in public domain. However, neither the accuracy nor completeness of information contained in this report is guaranteed. CARE Ratings is not responsible for any errors or omissions in analysis/inferences/views or for results obtained from the use of information contained in this report and especially states that CARE Ratings has no financial liability whatsoever to the user of this report

2 Exhibit 2 below showcases the rating actions undertaken by CARE Ratings in the first half (H1) of the fiscal year in the last 7 years and the trend in the same. On an average, 70% of the rating actions undertaken by CARE have been reaffirmations. Reaffirmations as a percentage of total rating actions have seen a steady increase in the last 4 years from 66% in H1 FY15 to 71% in H1 FY18. There has been a notable increase in the number of reaffirmations (32%) in H1 FY18 from that in the corresponding period a year ago. This indicates the consistency in credit quality for the majority of entities whose credit ratings were examined. Rating upgrades have accounted for 17% of CARE s rating actions on an average, while downgrades have been accounting for 13% of the rating actions. In H1 FY18, downgrades accounted for 13% of the rating actions while upgrades had a share of 16% i.e. a higher number of entities have been downgraded than upgraded this fiscal. There has been a marked rise in the number of entities that have been downgraded in the first half of the ongoing fiscal; 46% increase from that in H1 FY17 (excluding cases in the category Issuer Non Co-operation ). Weakening credit profile, delays in debt servicing, delays in project execution, fall in profit margins, losses, stressed liquidity position and overall deterioration in asset quality (in banks/ NBFCs) were the primary reasons for downgrades. Upgrades as a percentage of total rating actions have reduced over the past four years, from 23% in H1 FY15 to 16% in H1 FY18. Downgrades have been in the range of 9%-14% of the total rating actions. In H1 FY18, the entities that were upgraded registered an improvement in the financial performance & profitability as well as operational factors. They were also found to have seen an increase in scale of operations, improvements in liquidity, debt servicing ability and capital structure which influenced upgrades. 2

3 Industry-wise ratings changes The MCR across key industries during April-Sept (H1) in FY15 18 is highlighted in Table 1 below. Table 1: Industry-wise MCR Industry H H H H Auto Banks Beverages Cement and related products Ceramics Chemicals and chemical products Construction Education Electrical Equipment Electricity - Generation Electricity - Transmission and distribution Financial Institutions Food and food products Hospitality Human health and social work activities IT, ITES and Communication Iron and Steel NBFC NBFI Other Financial Companies Other Machinery Other manufacturing Pharmaceuticals Real Estate activities

4 Rubber and plastics Products Sugar Telecom Textiles Transportation and storage Wholesale and retail trade Auto, Beverages, Cement, Chemicals, Construction, Electricity (generation, transmission & distribution) and Pharmaceuticals were some sectors that saw an improvement in their credit quality in the current fiscal. These sectors registered a higher number of rating reaffirmations and upgrades. Electrical Equipment, Food and food products, Hospitality, Health, IT, ITES & Communication, Other Manufacturing, Real estate, Telecom, Textiles and Wholesale & Retail trade were sectors that have witnessed a moderation in their credit quality this fiscal year. MCR for automobile and auto ancillary companies increased from 1.02 in H1 FY17 to 1.06 in H1FY18 showing higher number of upgrades than downgrades, mainly because of the buoyancy witnessed in automobile sales. Lower cost of ownership of auto vehicles triggered by series of interest rate cuts, push on manufacturing and infrastructure segment by the government combined with lower fuel prices have resulted in recovery of auto sector. Industry stands to benefit from this turnaround in Original Equipment Manufacturers (OEM) demand and stable replacement demand. Upgrades were also triggered by improvement in capital structure due to equity infusion in few cases and reduced debt levels. Higher downgrades in the Banking sector are driven by concerns over the asset quality of banks with higher NPAs, deterioration in profitability and capital adequacy parameters. Companies in Beverages witnessed a significant improvement in MCR in H1 FY18 mainly due to the improvement in scale of operations, profitability and capital structure. However, it may be noted that most of these upgrades were in the Below Investment Grade category. MCR for cement sector has shown a sharp improvement in H1 FY18. After witnessing a slowdown in demand and production on account of demonetization during FY17, the cement sector has started exhibiting signs of revival with all India production witnessing a y-o-y increase of 1.9% for the month of May 2017 vis-à-vis May On the pricing front, although, the cement prices witnessed a short lived decline post demonetisation, on an annual basis, the average cement prices witnessed growth during FY17 primarily on account of increased prices in the northern markets. Overall, the revenue increased during Q4FY17 backed by high volume sales for majority of the listed cement companies. Volume growth along with improved capital structure triggered upgrades in the cement sector. The construction sector upgrades have been driven by the improvements in the order book position of entities, improvements in liquidity position and capital structure and debt coverage indicators. MCR for Electricity Generation companies has also improved in H1 FY18, mainly in the Renewable energy sector, aided by boost provided to the sector by the Government attracting strong promoter groups and companies establishing strong debt protection mechanisms and liquidity cushions in the form of credit enhancement measures. Successful completion of projects, tariff revisions, improved profitability and enhanced scale of operations led to the improvements in credit quality in this sector. The upgrades in the Electricity-Transmission and 4

5 Distribution industry have been aided by improvements debt coverage indicators, capital structure, growth in scale of operations and comfortable liquidity position. IT, ITES and Communication industry witnessed higher downgrades in H1 FY18. The downgrades in this category were mainly in the Media companies that faced lower income levels and profitability due to reduced Ad spends post demonetization. Debt coverage indicators were accordingly affected with companies resorting to higher debt. Downgrades in the Iron & Steel sector were mainly in the below investment grade companies triggered by stressed liquidity position and over leveraged capital structure of the players resulting into delays in debt servicing for some of the companies. Downgrades in the Other manufacturing companies mainly included downgrades in the Gems and Jewellery companies due to low profitability and stretched liquidity position. Higher downgrades in the Real estate sector in H1 FY18 were on account of drop in bookings, subdued sales, delays in project implementation and in a few instances, delays in debt servicing. Although downgrades in the sector increased in H1 FY18, there has been an increase (85%) in the number of entities whose ratings have been reaffirmed. The Telecom sector witnessed high downgrades in H1 FY18 due to intense competition affecting the profitability and liquidity of players in the industry, also resulting into delays in debt servicing in few cases. High downgrades in the Wholesale and Retail trade in H1 FY18 were mainly due to increased competition in the sector impacting the scale of operations and already bleak margins, leading to liquidity stress and delays in debt servicing in few cases. However, it may be noted that most of the downgrade in this sector were within the Below Investment grade cases. 5