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Consequent to the funding problems that the NBFC and HFCs have been facing over the last few months, securitisation of retail portfolios have picked up considerable pace, with volumes of Rs 18000 Crores in the month of October alone. The advantage of securitisation transactions is that the investors are not exposed to entity level credit risk and have exposure primarily to the underlying pool of retail borrowers. However yields have gone up significantly with the changing market dynamics. ICRA believes that the momentum in the securitisation market is likely to remain strong in the current fiscal as it is emerging as an important tool for retail focussed NBFCs for raising funds at reasonable costs while simultaneously providing a hedge against Asset Liability mismatches.

We also analyse the performance of the Indian corporate sector based on a sample of companies for Q2 FY2019. While revenue growth was strong , especially in consumption-oriented and commodity linked sectors, aggregate EBITDA margins declined considerably because of rising energy and raw material prices as well as the impact of depreciating rupee. We also analyse some of the key sector specific trends that have emerged on the basis of the Q2 results

We also look at the pricing dynamics and outlook for the pharmaceutical companies which have a significant presence in the US generics markets. As pre ICRA research, the pricing pressure in the US generics market is expected to normalise and consequently operating profits are expected to show favourable movement in the next 12-15 months. ICRA believes that because of pricing pressures , the mid and large size pharma companies will be more selective in new launches , additionally some of the players have also exited segments where the pricing was turning out to be unsustainable .

Finally we also discuss certain macro economic themes. As anticipated, the repo rate was left unchanged at 6.5% by the Monetary Policy Committee (MPC) in the December 2018 policy review. However, contrary to our expectations, the Committee left its growth forecast unchanged at 7.4% for FY2019. On expected lines, the inflation projections have been revised downwards, even though in our opinion, the outlook for food inflation remains mixed. In case inflation continues to be benign, we expect a substantial likelihood of a change in monetary policy stance back to neutral from calibrated tightening in the February 2019 policy review. Also we expect the Reserve Bank of India (RBI) to continue to address structural liquidity mismatches through Open Market Operations (OMOs) rather than a cut in the CRR in the near term.

The issue concludes with the regular features: monthly rating updates, upcoming ICRA events, and news features related to the company.

I hope you will find this newsletter useful and informative.

Best Regards

Anjan Ghosh
Chief Rating Officer, ICRA Ltd

 
 
  From ICRA Research
   
  Securitisation helps retail-focused NBFCs to tide over the liquidity crisis
 

kinjal The securitisation market has witnessed heightened activity in recent times, driven by the large-scale funding requirements of non-banking financial companies (NBFCs) and housing finance companies (HFCs). According to ICRA’s research, the securitisation volumes soared to around Rs. 18,000 crore in the month of October 2018 alone, with many entities raising funds through the sell-down of their retail portfolios to banks. In comparison, the securitisation volumes were around Rs. 66,300 crore till H1 FY2019 and around Rs. 83,800 crore for the whole of FY2018. These funds helped meet the sizeable repayment obligations of the NBFC sector (around Rs. 78,000 crore of commercial papers (CPs) were due for repayment in October 2018) in an otherwise difficult market, says ICRA in its report. The securitisation market in India can be segregated into two types of transactions – rated pass through certificate (PTC) transactions and unrated direct assignment (DA) transactions (the bilateral assignment of a pool of retail loans from one entity to another).

Other funding avenues had dried up for the NBFC sector with capital market investors becoming wary of taking incremental exposure to some entities and a general freeze in the credit markets owing to tight liquidity. The advantage of securitisation transactions, especially in the current market scenario, is that the investors are not exposed to entity-level credit risks and are seen taking exposure to the underlying pool of retail borrowers to whom these entities have lent. Even banks that have exhausted single-party credit limit to an entity can do business with that entity by buying its retail loan portfolios. Both public and private sector banks have participated in a big way. However, yields have gone up significantly (by around 100-200 basis points in October 2018 compared to H1 FY2019), as the market dynamics have changed completely – from being a sellers’ market earlier to becoming a buyers’ market now.

While the liquidity position seems to be easing, the momentum in the securitisation market is likely to remain strong in the remainder of the quarter as there are significant redemptions falling due in the months of November and December 2018 as well. The securitisation market in India is growing rapidly and becoming more broad-based with volumes in the current fiscal (till October 2018) already exceeding the full year volumes witnessed in the previous fiscal. Securitisation is an important tool for retail-focused NBFCs as it provides them with funds at an attractive cost while simultaneously providing a hedge against the asset liability mismatch (ALM) risk.

Priority sector lending (PSL) requirements of banks have remained the driving force behind securitisation volumes over the past several years. However, in recent years, the share of non-PSL backed transactions is on the rise with increasing participation from mutual funds and NBFCs as investors. In H1 FY2019 and FY2018, the share of non-PSL transactions increased to around 35% compared to around 24% in FY2017.

Priority sector lending certificates (PSLCs) are an alternate avenue available to banks for meeting PSL requirements. PSLCs have gained widespread acceptance in the market with traded volumes of around 1.78 lakh crore in H1 FY2019 against 1.84 lakh crore for the whole of FY2018. Both PSLCs and the co-origination framework permitted by the RBI recently – where banks may partner with NBFCs for onboarding PSL assets – may adversely impact the PSL volumes in the medium to long term.

  Mixed quarter for the Indian corporate sector as margins decline on back of rising cost headwinds
 

The Indian corporate sector has registered a revenue growth of 23.9% on a YoY basis during Q2 FY2018-19. An ICRA study of a sample of 176 companies has indicated that sales growth was stronger in commodity-linked sectors (iron and steel, oil and gas and cement) and consumer-oriented sectors (FMCG, consumer durables and airlines). The commodity-linked sectors posted 61% revenue growth on a YoY basis, supported by higher oil and steel prices, and healthy demand for cement. Excluding commodities, revenue growth for the rest of the sample was 13.7% YoY, which too is relatively higher vis-a-vis the previous quarters.

Although revenues grew at a healthy pace in Q2, the aggregate EBITDA margins declined by 220 bps on a YoY basis and 70 bps on a QoQ basis to 18.1% because of the rising energy and raw material costs as well as the adverse impact of the depreciating rupee. While sectors such as airlines, cement and building materials (tiles & glass) reported a decline in EBITDA margins because of the sharp increase in fuel prices, sectors such as automobile OEMs, consumer durables, paints and media (newsprint) also saw margin contraction because of rising input costs. Overall 21 out of the 32 sectors in ICRA’s sample reported a decline in EBITDA margins on a YoY basis because of the rising input costs and/or increase in fuel costs.

In terms of sector-specific trends, results in consumer-oriented sectors was a mixed bag. While the automobile segment saw the growth momentum losing steam, other consumer-oriented sectors, especially consumer durables and FMCG continued to clock healthy volume growth. Within the automobile sector, the passenger vehicle segment registered a decline of 3.6% in domestic sales in Q2 FY2019 on a YoY basis because of the delayed festive season, high base and rising ownership cost (fuel, EMIs and insurance). Likewise, the 2W segment also registered tepid growth of 4.9% in Q2 driven by a steep price hike after the change in insurance guidelines for third party cover and delayed festive season.

The narrative on rural demand continues to be stable with most companies suggesting that rural outpaced urban growth although not by a substantial gap. Most companies expect the rural growth momentum to remain stable, supported by expectations hike in MSPs and overall thrust on agri-economy ahead of the elections.

The IT sector reported healthy revenue growth of 9.2% (in USD terms) supported by an increasing share of digital offerings and pickup in demand from BFSI clients. The aggregate EBITDA margins of IT companies improved by 30bps to 23.3% on a YoY basis. The tailwinds, because of INR depreciation, helped IT companies offset the impact of rising employee costs.

With pick-up in construction activity and new order inflows, the domestic steel and cement consumption was also healthy in H1 FY2019, up 11.3% and 14.5%, respectively. However, while steel companies reported improved margins (on back of higher realisations), the increase in pet coke prices and logistics cost adversely impacted EBITDA margins of cement companies.

The financial performance of the airline sector has been adversely impacted because of the sharp increase in jet fuel prices, the rupee depreciation and the pressure on yields owing to stiff competition in the sector.

  Pricing pressure in the US generics pharma market to stabilise over the next 12-15 months
 

Indian pharma companies with significant presence in the US generics business, which have been grappling with slow growth on account of intense US generics pricing pressure, and eroding operating profits, are likely to see favourable times in the next 12-15 months.

As per an ICRA report, covering a sample of seven large Indian pharma companies, the US generics pricing pressure is expected to normalise, going back to earlier levels of low to mid-single digits. Positive and selective price changes too are not ruled out, as against the low teens pricing pressure seen during CY2017 and 10-12%, estimated by ICRA during CY2018.

The competitive intensity of the US generics business and the pricing pressure thereof was due to the consolidation in distribution supply chain and monopolistic conditions, with three large buying groups controlling 90% of the distribution channel. This, coupled with the faster pace of ANDA approvals adopted by USFDA, too has played its part. Consequently, the US generics business, which has been a significant contributor to growth and profitability for Indian pharma players over the last decade faced a slowdown registering a growth of 4.0%, -13.1%, 1.5% in FY2017, FY2018 & Q1 FY2019 respectively.

The faster pace of ANDA approvals by USFDA impacted generic prices, thereby increasing competitive intensity. ANDA approvals rose from 409 in FY2014 (October to September period) to 763 and 781 in FY2017 and FY2018 respectively. The pace increased because in October 2012, the Generic Drug User Fee Act (GDUFA) was implemented in the US leading to increased pricing pressure. Before GDUFA, while the average approval time was 36 months, under the GDUFA, action on 90% of the standard ANDAs submitted needs to be taken within 10 months and; for priority ANDAs, the timelines have been reduced to eight months, subject to meeting certain requirements. Priority ANDAs are those drugs that have less than three approved generics or Para IV filings among others. The USFDA has already issued draft guidelines to promote entry of complex generics such as complex transdermal and topical and is further expected to issue guidelines for injectables, metered dose inhalers, peptides under the Drug Competition Action Plan, thereby simplifying the scientific evidence required to show bioequivalence.

The aftermath of this measure is that while higher ANDA approvals lead to intense competition, the mid and large-size pharma companies will be selective in new launches owing to inadequate profitability, enabling normalisation of prices to some extent. Already between October to September in FY2018, the companies have withdrawn 606 approved ANDAs, as compared to 214 and 248 withdrawals in FY2017 and FY2016 respectively.

ICRA note says that, domestic pharma players have exited several products where pricing was unsustainable in the last 12-15 months; the freed capacities have been realigned for manufacturing higher volumes of existing products having strong market, so as to benefit from economies of scale or for new product introductions. The initiatives are likely to reduce competitive pressures and normalise prices.

On the R&D front, companies are rationalising their spending by dropping plain vanilla generics development where there are already several ANDA filers awaiting approval or existing competition is high. They are instead focussing their spends towards complex generics, specialty products including NCEs (New Chemical Entities) & NTEs (New Therapeutic Entities) and bio-similars where less competition is expected. Players are progressively focusing on developing value-added generics (NTEs) by combining drugs, new route of administration or dosage forms which allows them certain exclusivity and at the same time the risk-reward ratio is more favourable. These drugs are an improved or enhanced version of the approved drugs. The average R&D cost (as a %age to sales) has reduced from 9.0% in FY2017 to 8.8% in FY2018 and 8.6% in Q1 FY2019 for ICRA’s sample and is expected to remain at similar levels.

The companies’ operating profits, which fell from 26-28% till Q3 FY2017 to the current 19.0-21.0% has been cushioned by the cost reduction exercise, undertaken across various expense heads selling, general and administrative expenses (SG&A), research & development (R&D) as well as employee costs - a result of the streamlining of the product portfolio and manufacturing facilities.

Going forward, the profitability is likely to be affected by the new launches, thereby absorbing the impact of the ongoing pricing pressure. ICRA expects that a significant reduction in prices will render the US generics business unattractive for many players enabling stabilisation and positive price changes in the medium term. Further, Indian companies with a pipeline of complex generics will benefit from the faster approval cycle and higher margins before other complex generics entriesintensify pricing pressure. All these combined initiatives are likely to reduce the competitive pressures, enabling normalisation of prices and augur well for the Indian pharma players in the medium term.

     
  MPC pauses in December 2018 amid heightened uncertainty to inflation outlook
 

As expected, the Monetary Policy Committee (MPC) left the repo rate and the monetary policy stance unchanged at 6.5% and calibrated tightening, respectively, in the December 2018 policy review, with food and core CPI inflation displaying contrasting trends, and uncertainty related to major components of the inflation outlook. While the vote on the repo rate was unanimous, there was one dissent in favour of changing the stance back to neutral.

Following the sharp sequential dip in GDP growth in Q2 FY2019, we had expected the MPC to cut its growth forecast for the current fiscal. However, the Committee left its growth forecast for FY2019 unchanged at 7.4%, and placed its forecast for H1 FY2020 at a healthy 7.5% with risks tilted to the downside. In particular, with capacity utilisation rising to a seasonally adjusted 76.4% in Q2 FY2019, the MPC remarked that the output gap remains virtually closed, which is an encouraging sign for further capacity expansion.

As anticipated, the MPC revised its inflation projections downwards, forecasting the same at 2.7-3.2% in H2 FY2019 and 3.8-4.2% in H1 FY2020, with risks tilted to the upside. Emphasis was placed on the extent of uncertainty towards inflation risks related to factors such as prices of food and fuels, and the potential impact of volatile global financial markets and domestic fiscal slippages, particularly given the elevated level of the core-CPI inflation.

Going forward, geopolitical developments and supply-demand balances would continue to affect crude oil prices, the sentiment toward the INR, and the inflation outlook. Our base case does not factor in a sharp rebound in crude oil prices or a re-testing of the all-time low by the INR.

However, the outlook for food inflation remains mixed, with lagging rabi sowing and the potential impact of revised minimum support prices for various crops on market prices, casting some doubt on how long food prices would remain in the disinflation zone.

The extent of the variability in the individual MPC members’ inflation outlook may be clarified in the upcoming minutes. At present, there appears to be a substantial likelihood of a change in the monetary policy stance back to neutral from calibrated tightening in the February 2019 policy review, as a precursor to a repo rate cut in Q1 FY2020, if the feared inflationary pressures do not materialise.

As expected, the Central Bank did not cut the cash reserve ratio to ease liquidity conditions, having already conducted substantial open market operations (OMOs) to purchase Government of India securities (G-sec) of Rs. 1.36 trillion in April-November 2018, and having announced a pipeline of further OMOs of Rs. 0.4 trillion for December 2018. In our view, the Reserve Bank of India is likely to continue to address structural liquidity mismatches through OMOs and frictional liquidity mismatches through term repos with variable tenors in Q4 FY2019, rather than cutting the CRR in the near term.

     
 
           
 
   
Rating Updates for the month of November 2018
   
Upcoming Events
December, 2018: ICRA conference on Corporate Sector
December, 2018: Webinar on Indian Hotels Industry: Trends and Outlook
December , 2018: Webinar on Indian Banking Sector: Performance and Outlook
ICRA in News
The Economic Time: 05th December, 2018: Telecom sector recovery may take time: ICRA
Business World: 07th December, 2018:Uncertain Inflation Outlook Prompts MPC To Pause
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