Debt Free Companies In Current Market Scenario

One of the most important parameters while analysing quality stocks is the debt levels of the company. Often, excessive levels of debt are considered negative for stocks performance but should all debt-free companies be considered good for investments? Geyatee Deshpande explains the merits of focussing on debt-free companies while identifying quality stocks.


A stock can go up for multiple reasons at any given point of time. The reason why stock prices jump could be better than expected profits, higher sales growth, better profit margins, a big order wins, a macro event which uplifts the overall sentiment thus, pushing higher majority of stocks or even an institutional investor taking exposure in the stocks in a big way. However, in the long-run what works consistently in the favour of any outperforming stock, is the quality and the durability of the growth in terms of sales and profits while maintaining healthy profit margins. To put bluntly, we can say that the stock returns are mostly positively correlated to profits and sales growth along with other fundamentals as reflected in higher RoEs, positive economic value added (EVA) etc., over longer periods. These are the kind of quality stocks that are most desirable by long-term investors.

One of the most important desirable quality aspects that every analyst focuses on while identifying a stock for long-term investments is the ‘Leverage’! Indeed, studying the debt levels of the company has always been one of the most important aspects of identifying a quality stock. More so in today’s world, studying the debt levels of a listed company has become important, where dozens of so-called ‘stable businesses’ are going bankrupt and ‘established brands’ are literally entangled in a debt spiral. Logically, lower the debt levels a listed company has, more promising the growth prospects can be for any listed company, simply because the margins will be higher for the low debt or zero debt companies. Going by the same logic, the prospects should be much better for those companies which have no debt on its books at all- isn’t it?

While the answer may not be objective enough to excite investors and lure them to make investment decisions based purely on the zero debt levels of the company, the latter should be a part of scanning list of any fundamental investor.

Arvind Mehta who has been investing in markets for over two decades says, “My investment process includes filtering stocks for their fundamentals. While I am doing so, I give a lot of preference to zero debt companies as I think it is an important advantage the company has when compared to its competitors”.

Being zero debt is good for sure as there is no interest cost servicing to be done. The riskiness of conducting the business is less and especially in the periods of economic slowdown and turbulence, the survival rate of such zero debt companies will be much higher.

Performance of Zero debt companies

We checked the performance of zero debt companies in 2019 and noticed that the performance is mixed. We considered only those stocks that have market capitalisation greater than Rs 500 crore. There are close to 160 zero debt stocks across various sectors listed on bourses with more than Rs 500 crore market caps. Out of these 160 stocks, we found that 71 zero debt stocks have yielded positive returns in 2019. The average return for all the zero debt stocks has been approximately 3 per cent.

However, we concluded that the zero debt companies from Finance, Capital goods, Healthcare, Consumer durables and Insurance sector have performed comparatively better.

Zero debt companies : Finance sector



We observed that out of 17 stocks from the finance sector which are zero debt, 9 have given positive returns. The best-performing zero debt stocks in this sector are Reliance Nippon Life Asset Management, HDFC Asset Management Company, Multi Commodity Exchange, Bajaj Finserv, BF Investments and Ujjivan Financial Services. The average YTD return for all the 17 zero debt companies from finance sector is 14.60 per cent. 

Zero debt stocks : Healthcare sector



We found that out of 16 stocks from the Healthcare sector that are zero debt, 11 stocks have given positive returns and the best-performing stocks in the sector are AstraZeneca Pharma India Ltd, Dr. Lal PathLabs Ltd, Abbott India Ltd, Amrutanjan Healthcare Ltd, Pfizer Ltd and Procter & Gamble Hygiene and Health care. The average YTD return of all zero debt healthcare companies is 22.41 per cent. 

YTD performance of Zero Debt companies


Zero debt stocks : Insurance sector 

In the insurance sector, we find that 3 zero debt stocks out of 5 have given positive return. The average YTD return of all zero debt insurance companies is 24.68 per cent. The best performing companies are SBI Life Insurance, ICICI Prudential Life Insurance and HDFC Life Insurance.

Zero debt stocks: Capital Goods sector


We also found that out of 16 stocks from the Capital Goods sector that are zero debt, 11 stocks have given positive returns and the best performing stocks in the sector are Nesco Ltd, GMM Pfaudler Ltd, Siemens Ltd, Esab India Ltd, Rites Ltd and Bharat Electronics Ltd. The average return of all the zero debt stocks is 11.68 per cent. 

Zero debt stocks : Consumer Durables Sector


When considering the Consumer Durable Sector, we observed that there are 4 zero debt companies namely, Whirlpool Of India Ltd, Honeywell Automation India Ltd, Symphony Ltd, TTK Prestige Ltd and the average return of these companies in the Consumer Durable Sector is 17.29 per cent.

Why zero debt companies are not always good?

It does sound as a wonderful strategy to invest in zero debt companies but it not logical to simply include the zero debt companies in the portfolio just because they are ‘zero debt companies’. Debt actually is a lower cost source of funds for any company.

What investors are looking for is optimal growth. In a strong economic growth outlook and a lower interest rate regime, a company can actually use leverage to add capacity and grow optimally. In spite of a strong vision of the growth, if the company adopts a low leverage option, there are chances that the company may lose market share to its competitor. A proactive strategy may be required in a growing economy to tap growth optimally. Optimal leverage in such condition helps tap growth opportunities and zero debt companies may underperform in such a market environment. Also, the zero debt companies may lose out on tax shield.

Another well-documented disadvantage of being a zero-debt company is the ‘management discipline’. It is observed that leveraged companies are more disciplined in their expenditure, as compared to those companies that enjoy higher cash flows and higher income. Complacency kicks in for zero debt companies when compared to a leveraged company which may lead to unwarranted expenses and inefficiencies.

Conclusion

Blue Dart Express, Wabco India, eClerx Services, GlaxoSmithkline Consumer Healthcare, HCL Technologies, Bayer Cropscience and VST Industries are some of the multibagger stocks that have had low debts on their balance sheets.

The biggest positive of having a zero debt stock in the portfolio is that these stocks have little exposure to interest rate risks and are insulated from any rise in borrowing cost. Zero debt companies will face no strain in cash flows as experienced by leveraged companies.

Also the low interest outgo for zero debt companies allows the company to retain more cash. The excess cash can be strategically used for tapping growth prospects or for distributing dividends. It is quite possible that the zero debt companies enjoy a scarcity premium over their leveraged peers. It is possible to see several multinational companies (MNC) to feature in the list of zero debt companies.In the current environment with no meaningful cut in interest rates expected for few quarters and given a low growth environment, companies with low debt or companies that are debt free can be preferred for investments.

While investors can and should consider the quality of zero debt-free companies to be included in the portfolio, there is no guarantee that a company will outperform simply because it is debt-free. Just because a debt-free company has better chances of survival in the downturn, does not mean that it will outperform when the market condition reverses. Investors should consider all other parameters such as consistent growth in profits and sales over the past few years before making any investment decisions.

Preference can be given to those debt-free stocks that operate in a growing industry. For example, if the outlook for the capital goods sector is positive, identifying the debt-free companies in the capital goods sector can be profitable. Debt-free companies do have an advantage but only a limited one.