Up to 27 of the 100 top companies listed on the National Stock Exchange (NSE) will not be able to maintain the current wage bill if their earnings fall by 30% or more due to a nationwide freeze and upcoming pay cuts, according to a Deloitte- Study said.
Given the slowdown in general consumption at all levels, companies need to assess their ability to pay, said Deloitte, who conducted a study of 100 companies listed on the NSE for market capitalization.
It says: “27 companies will not be able to maintain the current payroll from cash profits if their earnings decrease by 30% or more.” Indeed, the impact will be even greater as the funds stuck in inventories and receivables are likely to increase in such a scenario. “
These companies would either have to dive into their cash balance or take out short-term loans.
Without naming the companies, study 11 of the 27 vulnerable companies have a leverage ratio of more than 1, making it difficult to borrow to pay salaries.
“All covered companies have the opportunity to pay their fixed opex, interest and remuneration costs from cash and cash equivalents for a median of about 5.5 months,” the report continues. This coverage can take less than a quarter for 20 companies.
A nationwide ban, effective March 25, to curb the spread of the Coronavirus (COVID-19) has resulted in the closure of businesses and factories, flight and train closures, and restrictions on the movement of people and goods. This has led to a slump in consumption and weighed on the earnings of many companies.
“The situation seems less pleasant when you consider that other short-term liabilities from the same cover also have to be serviced for cash and cash equivalents. Even if shareholders were to take the most generous view of foregoing their share of the added value for the current year, even some of the largest companies in India are facing imminent wage cuts, ”it continues.
According to Deloitte, companies must assess their ability to pay salaries using the very effective parameter of the compensation cost coverage ratio.
The compensation cost coverage ratio considers the company’s cash profit before taxes and wage obligations divided by the wage obligations. The higher the quota, the higher the company’s ability to continue paying wages even if the cash profit decreases.
Even after taking into account the other possible payment obligations of the company such as planned investments, debt repayments, replacement / revaluation of depreciated assets and working capital requirements, a sustainable quota must be at least 1.5 or higher.
“However, a ratio of 2 or less may result in little return to equity providers,” it said.
With a 30% decline in sales, the 27 companies with a compensation coverage ratio of less than 1 can continue to pay fixed median opex, interest and remuneration costs for 4 months.
The survey of the 100 largest NSE companies showed an average cost recovery of 3.25. More than 60% of the companies had a compensation cost ratio of 4.
Deloitte stated that companies in the energy sector had a higher median compensation cost coverage ratio of 6.31.
This is because working capital and additional investments have a much higher share of operating cash flow compared to compensation costs.
The service sector is in second place with a median of 5.60. The median drops sharply to 3.4 when a public sector logistics company is removed from this service sector basket.
“It should be noted that companies in the service sector are likely to need a higher level of coverage, as their earnings are more likely to be associated with uncertainty and stress due to the blockage and continued norms of social distancing,” the study said.
IT companies have the lowest median of 1.51. Much of the operating cash flow goes into compensation costs for IT companies.
The study states that for several sectors, cash profits in the first quarters of fiscal year 21 may fall below their revenues due to a decrease in total consumption.
Sectors such as the retail, travel, and entertainment sectors continue to have near-zero sales, but still have operating expenses, leading to negative cash gains.
While 43 of the 100 companies fall below the quota of 3, six have an average quota of more than 10. The six companies are asset-intensive companies in the fields of energy transmission, mining and gas distribution.
Deloitte suggested that companies assess the compensation cost recovery rate under different scenarios and plan to maintain target compensation cost recovery by deferring compensation or including variable costs.
“It is advisable to ensure that coverage in the worst case scenario plan does not fall below 1.5,” he added.