ON THE BEATEN TRACK
Any one can fly high when the going is good. But the real stars are the ones who can take the rough with the smooth, who can weather a storm, and live to tell their story. India Inc has spawned many shooting stars only to see them fall by the way side. Trouble has eventually caught up with those charging ahead with overambitious plans, and in some cases, unsound business models. Inevitably, investors taken in by their heady promise have lost money. ET Intelligence Group turns the spotlight on a few such companies which are facing a rough time, for now
“Only when the tide goes out do you discover
who’s been swimming naked”—Warren Buffett
Anyone who is watching the global political and economic events today would be left in no doubt that the tide has certainly and decisively turned. What the economists and governments all over the world wanted the investors to believe, say, six months back can at best be called ‘wishful thinking’. If only wishes were horses. In fact, there is every indication that the trouble is not even half over and the tide is likely to ebb further.
Whether one should invest in such market conditions is debatable. There are some experts who strongly believe that India’s better economic growth conditions could act as a magnet for overseas investments. Retail investors are urged not to desert the market completely as they could miss out when the uptrend begins.
Whatever course the markets take over the next few months, investors should make sure they don’t end up with those, whom the Sage of Omaha would be glad to term as ‘swimming naked’.
A number of Indian companies are saddled with high debt and have low operating profits in relation to their interest obligations and, in some cases, negative cash flows. In such a compromising situation, they need a high tide to swim without being pointed out. However, they are the first ones to suffer when the going gets tough.
Life has become tough for this lot, as interest rates have gone up substantially over the last 12 months. High interest rates and a high debt pile means companies need to dole out a bigger sum every month towards interest. On the other hand, a weaker economic outlook means their profits will — if not already — face pressure. Top this up with the current conditions in the equity market that prevent any equity dilution plans to ease their pain. In the face of these adversities, companies are trying every trick in the book. Entrepreneurial ingenuity is working overtime to make ends meet. Some are trying to divest non-core assets in a bid to raise cash. A few are borrowing overseas where interest rates are still benign while others are wooing private equity investors or trying to list subsidiaries.
Needless to say, all these measures are shortlived. What is needed the most is a robust business model that can bring in sufficient internal accruals to take care of current debts and fund future growth.
Many of these companies had enjoyed high valuations when all was well, mainly because then they proved difficult to distinguish from the fast-paced growth stories. Now that their vulnerability has become visible, investors should be wary of taking on any bets lured by their low valuations, unless they fix their cash-leaking business models.
ET Intelligence Group lists a few such companies, which are finding the going to be tough at present.
Debt-Equity Ratio (DER) This shows the relationship between the money that owners and lenders invested in the business. Owners can wait for returns on their investment, but lenders don't. Hence, excessive debt in relation to equity increases risk.
Interest Coverage Ratio (ICR) This is a gauge of how easily a company can meet its interest obligations. Profit before interest and tax is divided by the interest obligation to arrive at this figure. Higher the interest coverage ratio, easier it is for the company to service its debt and vice versa.
Pledged Shares Promoters may pledge the shares they hold in the company as a guarantee for loans the company takes. A sharp fall in their value could prompt lenders to sell those shares and recover their dues if no additional guarantees are offered.
Operating Cash Flows This shows how much cash a company’s business generated during a year. If this is lower than its interest and debt repayment obligations during a year, it will need to borrow more to repay. All tables are based on FY11 numbers except Pledged Shares (%), which is at June 2011 end
India’s largest drilling rig owner Aban Offshore continues to reel under the huge debt burden it raised to acquire Norwegian company Sinvest in FY07. The $3.3-billion debt was restructured in FY10 to extend the repayment period providing it breathing space at a time when the drilling market globally had slowed down.
After low repayments in FY10 and FY11, the company will have to repay nearly 3,000 crore of debt in FY12. In addition, the estimated interest cost for FY12 works out to another 850 crore. Meeting these obligations appears to be a tough call in view of its dwindling cash flows. In FY10, the company had raised 700 crore through a preferential allotment. It recently sought shareholder approval for raising $400 million in overseas funding and 2,500 crore through a preferential allotment to qualified institutional investors. However, the crash in its share value in the last one year makes this an unattractive option for promoters.
Hyderabad-based Gayatri Projects has faced a slowdown in many of its construction projects due to the political uncertainty in Andhra Pradesh over the Telangana issue. Out of its 7,000-crore order book, half the projects are located in Andhra Pradesh. The company has amassed huge debt and servicing it is taking a toll on its profitability. Its plans to raise equity through preferential allotments did not take off due to poor market conditions.
It is now proposing to come out with a rights issue, which awaits clearance from SEBI. In FY11, the company’s operating cash flows fell short of its interest commitments. Gayatri has won a few projects of late, but they will need further funding from the company.
Aggressive investments in creating telecom tower infrastructure that failed to attract higher utilisation have resulted in a mounting debt problem for GTL. This has made investors jittery over the viability of GTL’s business model. The stock has lost four-fifth of its worth in the last five months. This could have serious ramifications since a chunk of the promoters’ shares are pledged.
The company ended FY11 with nearly 1,300 crore of cash and positive cash flows, which means meeting interest obligations may not be a big concern. However, repayment of its debt will be a key challenge.
For example, nearly 1,020 crore of FCCBs will need to be redeemed in November 2012, if the share price doesn’t move above the conversion price of 53 from the current 14. GTL is looking at debt restructuring and sale of stake in its subsidiary. The company’s future viability depends on how quickly it can close such deals.
A delay in government’s subsidy payments has resulted in Jain Irrigation borrowing heavily to fund its working capital needs. Nearly half of its revenues comes from sale of micro-irrigation systems to farmers, which enjoy over 50% capital subsidy from the government.
At the end of March 2011, the money locked in Jain Irrigation’s working capital stood at par with its cumulative investment in fixed assets since its inception. With growing debt and rising interest rates, the company’s interest burden in FY11 was higher than its operating cash flows.
The company is planning to float an NBFC, which can finance its customers in future and deleverage its balance sheet. The company is holding back on plans to raise funds through the issue of equity or quasi-equity instruments as its share price continues to languish below the comfort level. Still, we consider it ‘low risk’ because its debtors primarily consist of the government
With 2080 MW of running capacity and a further 5300 MW under construction, Lanco Infratech invested 3,400 crore in an Australian coal mine with a view to safeguard its fuel linkage.
Its balance sheet, already leveraged due to a huge capital work-in-progress, was further stretched due to this. The company’s debt-to-equity ratio as on March 31, 2011, was 3.8 against an industry average of 2.5.
On the other hand, factors like project delays, falling tariffs and costlier fuel have hampered its profitability and cash generation. For FY11, its interest coverage ratio stood at 3, which fell to 2.6 in the June quarter. The company plans to list its power business in future.
Full-service air carrier Kingfisher Airlines has been a cash guzzler from day one. During the 10-year period FY01 to FY10, it has lost over 3,500 crore.
The company’s problems emerged mainly as its high-cost model couldn’t break even against the competition from low-cost carriers. The economic slowdown in FY09 added to its woes.
The company underwent a debt restructuring exercise in FY11 that brought down its debt levels. Its plans for a GDR issue have gone for a toss in the weak market conditions and it is now contemplating a rights issue to shore up its equity. High fuel prices and stiff competition means it is still some way from making cash profits.
Ackruti City is one of the most highly-leveraged real estate players today. Rising debt and higher interest costs are taking a toll on its earnings. Interest cost alone amounted to over 30% of its FY11 net revenue, which jumped to over 54% in the June quarter. Stagnating profits and negative cash flows in FY11 have exacerbated the problem. After a healthy period that lasted the second half of FY10 and the first half of FY11, the company has seen sales and profits dwindling heavily in the last three quarters. The company has several residential and commercial projects scheduled to be completed in 2012, which could offer some support going forward.
JSL Stainless is one of the several steel makers that borrowed heavily to fund massive capacity additions in the last few years. However, with steel demand slowing down and raw material prices staying strong many producers are considering cutting down production. This scenario is detrimental to JSL Stainless as its debt is more than three times its equity with low interest coverage ratio. Moreover, cash flows from operations have not been very high. Near-term profitability is likely to suffer as interest rates are expected to remain high and production is likely to decrease. Though the company expects to come out of its corporate debt restructuring plan ahead of schedule, this would also mean its borrowing costs would rise. At the same time, the company has planned capacity addition at Kalinga Nagar, Orissa, with an investment of about 6,000-7,000 crore. It will be at least a couple of years before the benefits from this expansion start flowing in.
A slowdown in the progress of its irrigation projects in Andhra Pradesh and some hydropower projects has led to problems mounting for Patel Engineering. With cash flows from its ongoing projects drying up, it had to fund other projects through short-term borrowing. However, in the last one year the situation has gone from bad to worse. Till FY10 it had five consecutive years of negative cash flows from operations. Obviously, this means it had to borrow more to meet its interest obligations. The company’s woes have increased as it has failed to bag any major project in 2011 so far, while its 600-crore Lahori Nagpala hydropower project was scrapped.
Heavy initial investment and aggressive marketing plans resulted in Reliance Communications (RCOM) amassing a bulk of its debt over the last few years. A higher amount of debt in absolute terms itself need not raise an alarm given the capital intensive nature of the telecom sector. But what could cause concern for RCOM is its higher debt in the face of falling profits. The company has reported a sequential drop in net profit for the past eight quarters. If this continues, servicing the debt could prove to be a challenge.
The company is in talks with global funding agencies to restructure its debt portfolio. It recently obtained an underwriting facility for over 8,700 crore from the China Development Bank. It is also looking at a part-sale of its stake in its telecom infrastructure subsidiary. Such arrangements may reduce the impact of higher debt in the long term.
Suzlon Energy acquired its bunch of debt through costly acquisitions and debtor trouble. Net losses at consolidated level in FY10 and FY11 have only worsened matters. The company is grappling with not only high interest costs, but also repayment of the principal amount. Although its consolidated operating cash flows were positive for the last couple of years, they fell short of its annual interest and debt repayment obligations. Suzlon’s acquisition of REpower, which has substantial cash balances, has improved its liquidity condition. However, this has increased its exposure to Europe, which is facing the threat of an economic slowdown. The company has been consistent in getting orders and has amassed a 29,000-crore order book. Its proposed stake sale in Hansen and recovery of a huge sticky debt from a US customer will be key to its successful turnaround.
High-cost overseas acquisitions in FY06 and FY07 and losses on derivative bets have left Wockhardt with huge debt pile. It underwent debt restructuring and sold parts of the business in a bid to weather the storm. Although the debt burden is high, the company’s core business appears to have turned around. After a couple of years of low cash flows, its FY11 operating cash flows were higher than the interest payments. Also, it posted a net profit in FY11 after three consecutive years of losses. Its earnings have further improved in the June 2011 quarter. The company also recently found a suitor for its nutrition business for around 1,200 crore. But the ongoing litigation to wind up the company remains a drag on its share price. Thanks to the improving cash flows from its core pharma business, we regard this company as ‘low risk’.
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