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The Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) has cut the repo rate by 25 bps for the second time this calendar year, as widely expected. Despite lowering the inflation trajectory and the growth estimates for FY2020, the MPC maintained a neutral stance. It has not ruled out inflationary risks stemming from probability of weak monsoon, uptick in food inflation during summer and uncertainty regarding crude oil prices outlook. Besides, GDP estimates for FY2020 have been revised from 7.4% to 7.2%. Though the second rate cut in 2019 is likely to persuade banks to reduce the lending rates, improvement in the systemic liquidity condition will remain the key driver for passing on the benefits of the rate cut to borrowers. The RBI also increased the quantum of SLR eligible for computation of the liquidity coverage ratio (LCR). It aims to continue to take measures to improve liquidity conditions in the bond market. While the 10-year G-Sec yields are likely to be in the range of 7.2-7.5%, going forward, the movement of the same will depend on crude prices and geopolitical factors.

We also take a look at the Indian telecom industry, which continues to face difficult times and revenue decline amid intense competition and limited pricing power. The industry will witness the third consecutive year of revenue decline in FY2019. The rules of the game have changed with the entry of Reliance Jio three years ago. However, the situation may improve somewhat with slightly better average revenue per user and higher pricing expected in FY2020. Further, the anticipated deleveraging, if it materialises, can moderately improve the interest coverage and debt/EBITDA. Revenues are estimated to grow by 6% and EBITDA by 20% in FY2020. However, these will be on a lower base and will still be significantly lower than the peak of FY2016. The subscriber base of the industry, too, has not increased significantly over the last two years. The pressure on the industry has also reduced non-tax revenues of the Government of India, and the same may continue for some more time.

We also examine the Indian hotel industry, which is expected to report a strong top-line growth of 10-11% in FY2019, aided by a 5-6% growth in revenue per available room and increasing food and beverages (and MICE) income. The demand for rooms is expected to continue to grow by about 8-9% YoY over the medium term. This will be led by increasing domestic travel, buoyant MICE activity, and higher FTAs, aided by a low supply pipeline, despite near-term headwinds from global geopolitical concerns and increasing local airfare. ICRA research expects the demand-supply gap to remain the driver for the current upcycle. Also incremental capex is likely to be limited.

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
   
  Benign inflation, slowing growth drive back-to-back rate cuts; transmission in bank lending rates to remain a challenge
 

Priyesh N Ruparelia The 4:2 vote in favour of a 25-bps rate cut by the members of the RBI’s Monetary Policy Committee (MPC) resulted in the Central bank cutting the rates for the second time, this calendar year, and in line with the wider market expectations. The MPC maintained the neutral stance, despite the lowering of the inflation trajectory and the growth estimates for FY2020. While the year-on-year (YoY) CPI inflation print stood at 2.6% in February 2019, the forecasts for H2 FY2020 stood at 3.5-3.8% for H2 FY2020. The MPC highlighted the inflationary risks stemming from the probability of weak monsoons, an uptick in food inflation during the summer months and the uncertainty on the outlook on crude oil prices. At the same time, the GDP growth estimates were also revised downwards for FY2020 to 7.2% (6.8-7.1% for H1 FY2020 and 7.3-7.4% for H2 FY2020) as against 7.4% estimated earlier in February 2019.

We believe the measure opens space for a further rate cut in the year, though the MPC may choose to pause in the next upcoming Monetary Policy. Future actions would depend on data related to agricultural output from the Rabi harvest, the monsoon forecast, and fiscal policies adopted by the new Central Government, following the weak outlook for global growth and the necessity to provide an impetus to domestic growth.

The second rate cut in the current calendar year is likely to prod banks to cut the lending rates for borrowers. However, we believe that despite an additional cut in Policy rates, the transmission in banks’ lending rate will remain incomplete as the incremental build-up in their deposits continues to lag the credit growth and the interest rates on small savings continue at elevated levels. An improvement in the systemic liquidity conditions will remain the key driver to improve the bank’s ability to cut their lending rates.

With the RBI committed to providing adequate funds to the productive sector of the economy, it increased the quantum of SLR that can be eligible for computation of the liquidity coverage ratio (LCR). The banking system holds an estimated excess SLR of around 7.8% as on March 15, 2019, part of which is required to meet the LCR norms. With deposits growing at a slower pace, the measure would reduce banks’ requirements to hold excess SLR for liquidity requirements and they can now redeploy the same in credit, subject to their internal risk frameworks and adherence to capital adequacy requirements.

Despite a cut in Policy rates, the yield on new 10-year Government security increased by 5 bps to 7.33%, as the demand-supply mismatch is expected to continue for bonds. The large supply of bonds from the Central as well as the state governments and a likely reduction in demand from banks because of an increased portion of their SLR bond holdings, are now eligible for liquidity coverage requirements. Though the RBI stated that it will continue to take measures to improve liquidity conditions, however, the clarity on the continuity on open market purchase of bonds by the RBI during FY2020 and the extent of foreign capital inflows will remain the key drivers for the bond yields, apart from the inflation outlook.

Monthly instalments were expected to come down once the lending rates were linked to external benchmarks, however, the decision to defer this will also dash the hopes of any major relief. Given that the liabilities for Indian banks are largely fixed rate in nature, in our view, increased depositor education to improve their acceptability of floating rate deposits is a necessity before moving on to external benchmarking of loans and mitigating the interest rate risks for the banks.

Nonetheless, the proposal to improve the housing securitisation markets and create a secondary market corporate loans are positive announcements from long-term development in the credit supply mechanism by attracting a wider set of investors. With active markets for these assets and a wider investor base, the ability of exiting credit intermediaries to originate and sell down these loan assets could improve while freeing up their resources for fresh lending and enhancing credit supply to various sections of the economy. We await the detailed RBI guidelines aimed at further strengthening the domestic financial and credit markets.

Going ahead, we expect the 10-year G-sec yield to trade in a band of 7.2-7.5% in the remainder of this quarter. An upward movement in crude oil prices or other geo-political factors will remain as the key risk that could push up G-sec yields from the current levels. On the other hand, any announcement on the OMO purchases by the RBI is expected to cool off the yields.

  FY2019 to close with weak signals for telecom; minor recovery likely in FY2020
 

Priyesh N Ruparelia The Indian telecom industry continues to face tough times in terms of a revenue decline. As the industry continues to witness intense competition and limited pricing power, FY2019 would be the third consecutive year of revenue decline. The launch of services by RJio marked the beginning of intense price-based competition, which has continued. The pricing pressure so exerted on the industry manifested itself in severe deterioration in the financial performance, marked by a decline in revenues, lower profitability (even losses for some telcos) and low cash generation.

However, the last few months’ trends indicate some recovery with ARPUs showing signs of stabilisation. A modest increase in pricing is expected in FY2020, which is likely to reflect in better revenues and profits. The operators will also be bolstered by the planned deleveraging initiatives to the tune of Rs. 0.9-1.0 lakh crore. The estimated debt metrics of the industry are weak with an interest coverage of 1.1x and debt/EBITDA of more than 11x as on March 31, 2019. The anticipated deleveraging, if it materialises, can improve the interest coverage to 1.4x and debt/EBITDA to 8x as on March 31, 2020 although they are likely to remain high. The stress on the industry has impacted the Government’s non-tax revenues from the sector. ICRA expects FY2019 and FY2020 non-tax revenues to be in the range of Rs. 35,000 – Rs. 40,000 crore per year. Return of the auctioned spectrum by exiting telcos can result in a Rs. 1100-crore per year reduction in deferred spectrum pay-outs to the Government.

The industry revenues, which declined by 11% in FY2018 to Rs. 2.1 lakh crore, are estimated to decline further by 7% in FY2019. The industry EBITDA is estimated to reduce by 18% in FY2019, following a 21% erosion in FY2018 (Rs. 49,000 crore). However, based on the Q3 trends the decline in ARPU has been arrested and the incumbent operators are looking for triggers of an upward movement, with some operators implementing minimum recharge plans. FY2020 can witness the benefits of higher data usage, and a relatively more consolidated and stable industry structure, resulting in some pricing discipline. We expect minor improvements with revenues estimated to grow by 6% and EBITDA by 20% in FY2020. However, these come off a lower base and will still be significantly lower than the peak of FY2016.

As of now, there is limited visibility of the industry achieving the peak revenues seen in FY2016 with its subscriber base unable to witness significant growth over the last two years. It stood at 1176 million as of December 2018 and moderate addition is expected, going forward. At such subscriber level, the industry ARPU would have to improve from Rs. 116 (per month) in FY2018 to Rs. 155 for the industry to achieve FY2016 revenue levels (assuming non-mobile revenues remain the same).

Pressures on cash flow generation, in addition to the need for continued capex, have kept the debt levels elevated, estimated to be at Rs. 4.75 lakh crore by March 2019. The debt coverage metrics of the industry have remained stressed with estimated debt/EBITDA of more than 11x as of March 2019. The telcos have lined up sizeable deleveraging plans, which include equity infusion plans by most operators, stake sales in tower companies as well an IPO in the African unit by Bharti Airtel Limited. These plans are expected to result in inflows of around Rs. 1 lakh crore, which can lead to a reduction in debt to Rs. 4.3 lakh crore as of March 31, 2020.

Overall, despite the reduction in debt levels and some improvement in operating profits, the coverage indicators would continue to remain weak, as reflected by the estimated interest coverage of 1.4x and debt/EBITDA of 8x as on March 31, 2020. Over the longer run, benefits emerging out of the consolidation and greater stickiness of data usage could result in stronger pricing power to the operators, which has the potential to provide greater revenue visibility and drive the organic deleveraging.

The pressures on the industry have led to a reduction in non-tax revenues of the Government of India, with lower licence fee (LF) and spectrum usage charges (SUC). These two combined declined by 24% in FY2018 and are expected to decline further in FY2019. Exits by some operators may result in a sizeable quantum of spectrum, around 551 MHz across bands to be repatriated back to the DoT. ICRA expects FY2019 and FY2020 non-tax revenues from the sector to be in the range of Rs. 35,000-Rs. 40,00 crore per year. The proportion of the overall receipts to the total non-tax receipts is expected to be the lowest in the last six years.

  Domestic hotel industry to register topline growth of 10-11% in FY2019; RevPAR to grow 5-6% aided by both ARR and occupancy
 
Subrata Ray

The Indian hotel industry is expected to report a strong topline growth of 10-11% (as against ICRA’s expectations of 8.5%+) during FY2019e, aided by 5-6% growth in RevPAR and increasing F&B (and MICE) income. This compares favourably with the 2.5% reported growth (and ~4% adjusted growth for renovation/closures) during FY2018. The demand for room is expected to continue to grow by about 8-9% Y-o-Y over the medium term, led by increasing domestic travel, buoyant MICE activity and higher FTAs, despite immediate term headwinds from global geopolitical concerns and increasing local airfare. This aided by a low supply pipeline and robust domestic travel, will result in an estimated FY2019 RevPAR growth of ~5-6% growth. The RevPAR improvement is likely to be driven by uptick in both ARR and occupancy. Also, the RevPAR for FY2019 is likely to be the highest since FY2012.

ICRA research is currently tracking a premium pipeline inventory of 1,02,400 rooms across 12 key cities, up from 98,900 rooms in November 2018. The assessed supply growth has increased from 5% and 4,600 rooms to 7% and 5,800 keys in FY2020, with the biggest incremental supply happening in NCR and Goa. However, supply is still expected to lag demand and the demand-supply gap will remain the backbone for the current upcycle.

The industry’s operating margin is expected to improve by ~150 bps to 21-21.5% during FY2019E. Margins are expected to continue the growth trajectory during the next few years to hit a high of ~26% during FY2023P. Debt reduction measures undertaken by certain large industry participants have resulted in sizeable reduction in industry leverage levels over the past two years. However capex for larger players in the industry towards building new hotels will be limited, going forward as the Return on capital employed (RoCE) continues to be at sub-cost (lower than cost of) of capital and is expected to remain so at least until FY2020. This will discourage any major investments from these players. RoCE is expected to improve substantially to ~14% during FY2022.

As per ICRA, though pan-India average occupancy improved marginally by one percentage point Y-o-Y to ~66% in 9M FY2019, monthly occupancies were at the highest levels since FY2009, during 9M FY2019. The Average Room Rate (ARR) grew by ~2-3% to ~Rs. 5,900 in 9M FY2019. RevPAR also continued to improve in 9M FY2019, driven by uptick in ARR and occupancy. The 9M FY2019 RevPAR stood at ~Rs. 3,900 at a Y-o-Y growth of ~4-4.5%. The third quarter, Q3 FY2019 has been the 18th consecutive quarter of RevPAR growth. Although RevPAR growth has been steady over the past four years, the current RevPAR level is at more than 20% discount to the peak levels witnessed in 9M FY2009. All key markets except Chennai and Goa saw improvement in RevPAR in 9M FY2019.

ICRA expects the RevPAR for FY2019 to be the highest since FY2012. Strong demand in the gateway city of Mumbai will drive ARRs. Healthy demand and limited supply in Delhi (which has about 75% of the NCR inventory) is expected to drive ARRs in the region, while Gurugram would continue to struggle in the immediate term because of the DIAL Aerocity supply. Hyderabad and Pune are expected to be strong growth markets over the next two years while healthy demand will support Bengaluru, despite heavy supply addition.

In terms of demand and supply, domestic Revenue Passenger Kilometre (RPKM), a proxy for domestic travel, continued to exhibit robust Y-o-Y growth, growing by 19.2% during CY2018 (17.7% growth for CY2017). Growth of FTAs to India in CY2018 was lower at 4.5% (as compared to 14.6% in CY2017). “While Q1 CY2018 FTA growth was healthy at 9.9% Y-o-Y, the same slowed down subsequently due to the Nipah virus scare; heavy diversion of tourist traffic to the soccer world cup in Russia; Kerala floods; higher tax rates (GST) compared to a few overseas destinations; travel advisories by countries such as USA and UK citing deterioration in air quality and terror attack related tensions in Jammu and Kashmir. While 2019 brings new challenges—both geopolitical and local, ICRA expects FTA to grow by 3-5%. However, overall demand for premium hotel rooms is expected to stay strong at 8%+.

As for supply, although supply pipeline additions have picked up in the last few months, ICRA’s premium room inventory database (12 key cities) across the country indicates a CAGR of ~4.3% in supply during FY2019-FY2023. The expected growth is lower than the ~12% and ~8% compounded annual supply addition witnessed over the two terms of FY2011-2014 and FY2011-2018 respectively. Part of the incremental premium supply in FY2019 and FY2020 is coming from upscaling and rebranding of midscale hotels into premium category rooms. There are also several brownfield expansions in the pipeline.

Revenue growth for Q3 FY2019 for ICRA’s industry sample continues to show traction growing by 9.6%, supported by pickup across room revenues and F&B (including MICE segment). The Q3 FY2019 operating profit margins too have improved by ~120 bps to 26.4% (25.2% in Q3 FY2018) driven by increasing RevPAR and cost control on other expenses.

     
 
           
 
   
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