ICRA : Year-end Sectoral Views

December 30, 2021

Year-end Sectoral Views

Economy

Aditi Nayar, Chief Economist, ICRA Limited

While the emergence of the Omicron variant of the Coronavirus has reignited uncertainty, we are cautiously optimistic that the economic recovery in India will become more durable and broad-based in the coming year. Rising confidence should support a return of consumption to normalcy, boosting capacity utilisation and setting the stage for broad-based capacity expansion by the end of 2022. Moreover, the solid expansion in direct taxes will allow the government to prioritize growth-enhancing capital spending.

With a higher inflation target than other Central Banks, the MPC can justify prioritising growth for some more time. Nevertheless, the base case of gradually strengthening economic activity, with uncomfortably high domestic inflation, suggests that it is only a matter of time before the MPC starts to raise rates to prevent inflationary expectations from becoming unanchored. We continue to expect 50 bps of repo hikes in 2022. However, the commencement of policy normalisation with a change in the monetary policy stance to neutral may end up being deferred to April 2022 from February 2022.

Banking & Finance

Banking Sector

Anil Gupta, Vice President & Sector Head, ICRA Limited

The banking sector navigated well during CY2022, despite the challenges posed by the second wave of Covid-19 during Q2 CY2022. Even in the absence of relief measures such as moratorium on loan repayments or standstill on NPA classification, which were allowed during the first wave, banks were able to reduce their NPAs.

The Gross NPAs and Net NPAs for the banks declined to 7.2% and 2.3% as on September 30, 2021 compared to 8.3% and 2.7% as on December 31, 2020 on a pro forma basis. While the headline numbers improved, the standard restructured book at 2.5% of the advances and the elevated level of overdue loans remain monitorable.

Subdued credit growth and surplus liquidity continues to be a drag on the profit margins for the sector, however, improved recoveries for the past NPAs and declining credit provisions translated into better profitability which is likely to further improve in the coming year.

Non-Bank Financial Companies (NBFCs)

A M Karthik, Vice President & Sector Head, ICRA Limited

The NBFC (including HFCs; excludes infra focussed and govt-owned entities) sector experienced a roller-coaster trend over the last 12-18 months. The rebound in H2 FY2021 on the back of the pent-up demand, post relaxation of the Covid-19 lockdown, supported growth and earnings performance. The asset quality, notwithstanding the augmented provisions, remained a monitorable as the overall operating environment for all key asset segments - vehicle, mortgage, small business, unsecured credit (including microfinance) etc was still subdued. This fragile recovery was hindered by the second wave of the pandemic in Q1 FY2022. The impact was relatively limited vis a vis the past fiscal, with the sector bouncing back in Q2 FY2022 in terms of disbursements and AUM growth. The

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asset quality, however, was impacted with a sharp increase in the overdues and restructured book during Q1 FY2022, which only corrected partly in Q2 FY2022.

Against this backdrop, the regulator had brought in various measures to strengthen the regulatory and supervisory framework of the sector namely scale-based regulations, tighter NPA recognition/ upgradation norms and prompt corrective action framework (PCA). The policy around the Internal Capital Adequacy Assessment Process (ICAAP) and, the leverage policy for large NBFCs, which is expected to be announced in the near term, may result in some entities, depending on their exposure risk profile, enhancing their capital buffers. ICRA, in view of the second wave impact and the above regulatory changes, notes that the NBFC AUM growth in the current fiscal would be lower (~4-6%) than the previously anticipated level of 7-9%, without considering the impact of the new variant. The reported asset quality numbers would be impacted in the near term in view of the tightened regulations, which could lead to earnings-related headwinds for some players. The capital profile of the entities is expected to remain adequate in view of the limited growth witnessed in the past and a subdued outlook over the near term.

Small Finance Banks (SFBs)

Sachin Sachdeva, Vice President & Sector Head, ICRA Limited

The Covid-19 pandemic significantly impacted the performance of SFBs in FY2021 and H1 FY2022 with respect to growth, asset quality and profitability. The asset quality was impacted adversely as the product segment for SFBs is largely unsecured with a focus on the self-employed segment, which is more vulnerable to income shocks. Microfinance, which forms the largest product segment for SFBs in terms of assets under management (AUM), continues to face challenges following the spread of the pandemic throughout the country.

Though the sector witnessed some bounce back in growth in H2 FY2021, the asset quality weakened significantly. The budding recovery was again hindered by the second wave of the pandemic in Q1 FY2022, though the same was followed by recovery in Q2 FY2022. However, the asset quality continues to face pressure and the overdues increased further in H1 FY2022. ICRA expects the sector to witness improvement in AUM growth rate in FY2022 than FY2021, but the asset quality metrices are expected to remain weak, which would keep credit costs elevated and hence profitability subdued in FY2022. On the liquidity front, the SFBs are well placed given their access to deposits and their better refinancing ability, given their access to the call money market. Further, the capital buffers remain healthy for most of the SFBs, though some entities are yet to complete their initial public offers (IPOs) to comply with regulations.

Structured Finance

Abhishek Dafria, Vice President & Group Head - Structured Finance, ICRA Limited

The securitisation volumes originated by NBFCs and HFCs witnessed pickup during FY2021-22 despite the second wave of Covid surge on account of a lower base coupled with reducing Covid infections and improving economic activities across the country. Nonetheless, the threat of the newly discovered Omicron variant of Covid-19 may once again make investors cautious when purchasing retail pools as concerns on statewide or nationwide lockdowns resurface. We believe the securitisation market would continue to favour secured asset classes over the near term until the threat of Covid infections reduces substantially. The credit ratings for the existing transactions rated by ICRA are nonetheless expected to remain stable as the credit enhancements would be more than adequate to meet any shortfalls to the investors during temporary periods of stress as has been evident for the past 18-20 months.

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Corporate

Aviation Sector

Suprio Banerjee, Vice President & Sector Head, ICRA Limited

The domestic aviation industry, which reeled through heightened challenges since the onset of Covid-19 pandemic in CY2020, continued its turbulent journey in CY2021, with the resurgence of the second wave in the early part of 2021. The year started with sequential growth in domestic passenger traffic in January 2021, with the trend reversing in March 2021, due to the second wave. With declining fresh infections sequential growth was again witnessed in June 2021, which has continued till November 2021. The growth, however, has been much below pre- Covid levels, either on monthly or on a cumulative basis. The other challenge which the industry has been facing in CY2021 is rising Aviation Turbine Fuel (ATF) prices, which as of December 2021, has gone up ~ 67% on a YoY basis. With scheduled international operations, yet to start and domestic passenger recovery still a work-in-progress the Indian aviation industry is estimated to report a net loss of ~Rs. 250-260 billion in FY2022, with recovery in domestic passenger traffic to pre-Covid levels expected only by FY2024.

Basic Chemicals Sector

Sabyasachi Majumdar, Senior Vice President & Group Head, ICRA Limited

The demand outlook for basic chemicals is healthy given the uptick in activity expected in the end-user segments in FY2022 despite the second wave of Covid-19 which led to moderation in demand in Q1 FY2022. The decline in number of cases coupled with increased vaccine coverage and improved economic activity are expected to drive demand growth going forward. The demand recovery in a few segments would be gradual given the lingering impact of the pandemic and will be based on the uptick in performance of the end-user segments, particularly in case of products such as Phenol, acetone, pthalic anhydride, maleic anhydride etc. Prices of certain energy intensive chemicals such as Caustic Soda and Soda Ash, and chemical segments in which China is one of the major producers witnessed a significant increase owing to increased fuel costs and power shortage situation in China. While prices have started softening from late November 2021 owing to easing of power shortage in China, they are expected to remain healthy given the improved demand scenario. However, any subsequent waves of the pandemic and the consequent containment measures will remain a concern. Credit profiles of most ICRA-rated basic chemical players are expected to remain comfortable in 2022, supported by a diversified portfolio of products, wide applications of these chemicals and manageable leveraging levels. Debt levels will remain contingent on the capex plans in the industry. The debt coverage indicators are expected to remain stable with Total Debt/OPBDITA at around 2x for the FY2022-FY2024, while interest coverage is expected to improve marginally as compared from 7.5x in FY2021 levels to 8-8.7x in the next three years.

Commercial Real Estate-Office and Retail

Mathew Kurian Eranat, Vice President & Co-Group Head, ICRA Limited

Pent-up demand expected to translate into healthy office leasing traction in 2022; strong recovery in metrics of retail malls post second wave of pandemic: Resumption of work from offices, attempted by corporate occupiers in Q4 FY2021, got deferred due to the second wave of the pandemic with gradual resumption of offices now are expected from early 2022. Consequently, the new leasing demand had seen significant correction which, along with the addition of newly completed inventory, resulted in vacancies inching up across most large portfolios by around 5-10%,even as collection efficiencies remained healthy. Large office parks reported physical occupancy in the range

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of 10-15% as of September 2021; as office resumption picks up, it is expected to translate into healthy traction in new leasing activity, as the underlying demand potential from occupiers, who are mainly IT/ITES and global MNC companies, is estimated to remain strong.

Retail malls have witnessed a faster recovery in operational metrics and cash flows after the second wave, compared to the recovery after the first wave of the Covid-19 pandemic, driven by faster relaxation in the restrictions and improved vaccination coverage. The recovery trajectory is expected to sustain in H2 FY2022 driven by pent-up demand, high vaccination coverage, resumption of multiplexes which also coincided with the festive season. The recovery in rental income is expected to be up to 75% of pre-Covid rentals for FY2022, which was around 45-50% in FY2021. During FY2023, the rental income is expected to be in line or better than the numbers achieved in the pre-Covid years. While the risks of subsequent waves of pandemic impacting business operations will remain, the strong recovery trends underscore the long-term growth potential for the sector and assets with strong liquidity profile and financial flexibility are expected to fare well, despite the temporary disruptions.

Construction Sector

Abhishek Gupta, Assistant Vice President & Sector Head, ICRA Limited

The construction companies are likely to see healthy growth of 12-15% in FY2022 despite slower execution in Q1- FY2022 due to the second wave of Covid-19, as the impact was short-tenured and less severe than the first wave with construction activities permitted in most states. The order book-to-operating income ratio of most of the construction players is above three times, which provides revenue visibility and the pipeline of projects to be awarded also remains healthy. However, delays in land acquisition, and funding challenges faced by a few state governments remain key risks to the order inflows. Operating profitability is expected to moderate by 100-200 bps, with increase in key raw material cost and increased competitive intensity, though the benefits of improved execution scale will negate the impact to an extent. As the relaxations under the Atmanirbhar scheme are likely to be gradually removed in 2022, there could be an increase in working capital intensity and BG requirement. However, most large construction companies will have adequate liquidity cushion to absorb this. Nevertheless, small and mid-size companies could witness some pressure with increased BG requirements. Overall, the credit profile of construction companies is expected to remain stable in 2022.

Construction Equipment

Mayank Agarwal, Assistant Vice President & Sector Head, ICRA Limited

ICRA's outlook on the mining and construction equipment industry remains 'Stable'. The second wave of Covid along with an increase in equipment prices (following changes in emission norms and steep rise in input costs) coupled with muted rentals and erratic monsoons slowed down the volume growth post Q1 CY2021 and thus, the volumes for H2 CY2021 are estimated to remain weaker than H2 CY2020. While this trend is expected to continue for Q1 CY2022, ICRA believes that with easing of supply-side constrains and continued infrastructure push, the domestic MCE industry will report a 7-10% annual volume growth during CY2022 (CY2021 to witness 15-17% growth).

While cost increase associated with emission norm change and increasing input cost have been passed periodically by the OEMs, relatively volatile demand curtailed their ability to pass it on fully and hence, future hike in price of equipment remains inevitable. In terms of profitability, commodity headwinds and increased cost of logistics will weigh on profitability over the next few quarters.

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Gas Utilities

Sabyasachi Majumdar, Senior Vice President & Group Head, ICRA Limited

After witnessing some moderation in FY2021 due to the Covid-19 pandemic, the domestic gas consumption is expected to grow by 9-11% in the current fiscal, driven by demand revival, post easing of lockdown measures, increasing offtake by City Gas Distribution (CGD) entities, expansion in pipeline network, new LNG terminals and commissioning of new fertiliser plants. Further, despite the increase in gas prices, the cost economics remain favourable for CNG and PNG (domestic) compared to alternate fuels, although the competitive intensity is higher in case of industrial fuels. Despite large debt-funded capex expected over the next few years, the credit profile of the incumbents in the sector is expected to remain healthy with average interest coverage expected at 23.0x for FY2023 from 22.4x for FY2021 and Total debt/OPBDITA expected at 0.62x from 0.72x for the sector, supported by regulatory protection or dominant competitive position of most of the entities in this sector, besides healthy margins, liquidity and strong financial flexibility.

Hospitality Sector

Vinutaa S, Assistant Vice President & Sector Head, ICRA Limited

While the first few months of FY2022 were impacted because of Covid 2.0, the hotel industry witnessed faster- than-expected ramp up in Q2 and Q3 FY2022. This was because of easing restrictions, high pace of vaccination and pent-up demand, which has resulted in leisure travel within the country. Domestic business travel also started picking up, mainly to project sites/manufacturing locations from specific sectors.

The demand upswing resulted in pickup in occupancies, with 50%+ occupancy in Oct and Nov-21. Some premium hotels, especially at leisure destinations, also witnessed ARRs bounce back to pre-Covid levels in the recent weeks. However, on a pan-India basis, ARRs still remain at a 20-25% discount to pre-Covid levels as international and business-oriented traffic is yet to come back/recover in a meaningful manner.

The Omicron variant and the fear of an intense third wave of the pandemic has been a sentiment dampener over the last one week or so; and some cut down in discretionary business travel has been witnessed. However, hoteliers have not witnessed any major cancellations of retail/leisure bookings or events thus far. The situation is evolving, and demand will depend on the efficacy of vaccines and a further Covid wave.

Hospitals

Mythri Macherla, Assistant Vice President & Sector Head, Corporate Sector Ratings, ICRA Limited

The performance of hospitals is expected to remain strong going forward, driven by healthy ramp-up in elective procedure volumes and strong ARPOB levels. Pent-up demand and market share gains for organized players in the high-end/complex surgery space is supporting healthy occupancy levels while uptick in footfalls at metro centers of hospitals in addition to higher amount of surgical work is driving improvement in ARPOB. Overall, ICRA expects occupancy to improve to 62-64% in FY2022 from 52% in FY2021 for its sample set of seven listed hospital companies while ARPOB is expected to expand by 8-10%. Benefits from improving scale, cost-optimization efforts, and ancillary revenues from Covid-19 are expected to support margin improvement for the sample set to 19-20% in FY2022. Further, given healthy accruals and relatively lower debt levels, debt metrics for the sample set are expected to witness considerable improvement in FY2022. That said, evolving nature of the pandemic continues to remain a key monitorable.

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