It’s best time to buy cyclicals as financial health of firms begins to improve

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The outlook and sentiment for cyclical stocks are expected to turn favourable as the financial health of companies is getting better. Based on an analysis by Deutsche Bank, for the first time in six years, the debt-to-equity ratio of BSE 500 companies (ex-financials) has been at the lowest in FY17 at 0.8 times, compared to 0.96 times in FY16. The interest coverage ratio of 5.4 times in FY17 has also improved from 4.9 times in FY16.

Less borrowed, more repaid

According to data provided by Capitaline, net sales and operating profit of BSE 500 companies (excluding financials) grew over 8 per cent in FY17. Improving operational performance along with slow rise in borrowings (and consequently, interest costs) led to a jump of 13.4 per cent in adjusted net profit in FY17.

Long-term borrowings, which form a major part of total borrowings, have grown only 8 per cent in FY17 or in single digits in the last three fiscals (FY17, FY16 and FY15), compared to double-digit growth in the previous two years (FY13 and FY12). Many companies seem to have either borrowed less or repaid their loans.

“The debt-to-equity ratio in the two key sectors — materials and utilities — which have seen considerable balance sheet stress has improved over the last two years. The only exception to this trend is telecom,” Deutsche Bank pointed out.

Slew of positives

Improving liquidity, fall in interest rates, benign capital markets and stable exchange rate have been the main factors behind the better balance sheets which is likely to continue, according to Deutsche Bank.

This indicates a pick-up in the capex cycle — which remained dormant for many years — soon, and hence a re-rating in many cyclical stocks. The rally will also spread to public sector and private banks with higher proportion of corporate loans in their books and NPAs, due to pick-up in the capex cycle, growth and also recent moves by the government and the Reserve Bank of India on asset quality resolution. While metal and oil & gas stocks have jumped substantially in the last one year with gains of the respective indices on the BSE in the range of 30-40 per cent, infrastructure stocks from power and capital goods sectors have lagged with rise of just 14-20 per cent and therefore, providing value now.

ICICI Bank and L&T are the top picks of Deutsche Bank from the cyclical sectors.

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