When Smart Debt Restructuring Of Companies Can Make You Smile

During 2010 and 2013 Indian markets witnessed a new trend of companies funding their expansion projects through debt. Analysing the interest cost of 3,900 companies over the last five years, we can see that the year 2013 witnessed maximum increase of 25% in interest cost. Slowly, with the slackening in the economic growth, the focus of the companies turned to deleveraging and interest cost growth moderated to 18% and 12% in 2014 and 2015 respectively. However, due to lower cash flows, gap between interest cost and operating profit kept narrowing and thus led to pressure on bottom-line. In FY15, a large number of Indian corporates with significant obligation on its books had a few rounds of discourses with a couple of suitors to sell certain assets. The discourses, in any case, never emerged into anything solid, due to valuation tussles. The scenario, however, changed after the lenders to these corporates forced it to divest their assets as they wanted to contain the borrower’s soured loans and hence interest cost increase dipped to 6% in FY16. Therefore, in the last few quarters we have seen a flurry of deals as overleveraged companies sought to reduce debt.

According to RBI’s latest Financial Stability Report, leveraged firms-which are defined as those having either a negative net worth or a debt-to-equity ratio of at least 2.0-have deleveraged over the past six months. The proportion of leveraged companies has fallen from 19.4 per cent in September, 2015 to 14 per cent during March, 2016, while the share of total debt comprised by these companies has also fallen by 10 per cent to 20.6 per cent over the same period.
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Let us take a look specifically at the construction sector which was facing stressed demand conditions and the leverage was steep high. The average debt to equity ratio was 2.2x in 2014 which dropped to 2.10x in 2015 and most significantly in FY16 to 1.8x. The interest coverage (EBITDA/ interest) hovered around 1.3x for 2014 and 2015. We see that for 2016, the interest coverage ratio deteriorated on an average for a set of 217 companies to 1.01 due to slowdown in realty sector across India and situation turned more anaemic in Chennai, NCR and Mumbai which were main demand drivers. Companies across the board tried to reduce their debts.

In the past year, sale of assets has emerged as a quick-fix solution to corporate India’s debt miseries. In theory, such deals can help corporates to liquidate their assets and pay back some of their debts. We have covered a point by point understanding of couple of corporates where such arrangementstook place or is under process.

An organisation which stood out as truly newsworthy for its aggressive bid to diminish debt is DLF. The stock prices of the company had taken severe beating due to high debt levels, high inventory levels and slowdown in the realty market. The stock which once quoted at the highs of Rs289 per share during FY13 saw massive erosion in prices and reached lower levels Rs73 in FY16.Lately, DLF has been selling its business activities to curtail its mountain of debt.But this has largely been failed and the company could not bring down its debt pile as of date.

The company has a critical debt level of Rs20701 crore as of March 2016. On consolidate basis, debt of the company hikedup by 24 per cent in FY16. Rental arm of DLF Ltd,DLF Cyber City Developers (DCCDL) has debt share of Rs 12325 crore in total consolidated debt of Rs20701 crore.On standalone basis, DLF Ltd reduced its debt by 22 per cent in 2HFY16 to Rs 8419 crore from over Rs 10758 crore in 1HFY16. In the table as you see below, we note that an interest cost of Rs2615 crore is shrinking the bottomline to mere Rs549.4 crore.

To deleverage the balance sheet, promoters of DLF, KP Singh and his family decided to wipe out DLF Ltd’s debt recently. Singh family plans to sale their 40 per cent stake in DLF Cyber City Developers Ltd for Rs 12000-13000 crore and will infuse about Rs 10,000 crore by purchasing shares in preferential issue in DLF. DLF is also planning to raise Rs 3000 crore from institutional investors. After this debt restructuring, the company’s consolidate debt will be remarkably lower to Rs 7701 crore. We estimate that the company’s interest cost will be Rs972 crore, down by 62 per cent over FY16. The impact is clearly understood when at the net income level of Rs549crore of FY16, an interest cost saving of Rs1150 crore (considering the tax impact), can boost the earnings by 200%. No wonder, investors welcomed the step and DLF shares surged up by 13 per cent since June 3^rd 2016 till date. Stock prices of the company has risen by 40 per cent over one year and 46 per cent over six months.

Another company within this space to be mentioned is Jaiprakash Associates.

Jaiprakash Associates is the flagship company of the Jaypee Group engaged in engineering and construction, cement, real estate and hospitality businesses. The company which was once celebrated in the market for its rapid diversification,now has been facing mounting pressure from lenders due to its inability to service the debt. The stock once quoted above Rs 160 levels in early 2010. However, debt burden resulted in immense pressure on the stock price and the stock reduced to single digit level of Rs 5.30 in the June, 2016. Jaiprakash Associates has consolidated debt of Rs 61284 crore of March-16 and company is planning to reduce its debt by sale of assets. In 2HFY16, company has reduced debt by 3 per cent on standalone basis over 1HFY16. Consequently, JPA’s stock has surged over 35 per cent in the last three months and the stock prices have almost doubled from the lower level of Rs 5.30 in the last 1 month or so.

As of now JPA’s interest cost of Rs7515crore far exceeds its EBITDA levels of Rs4750 crore which raises a question on its ability to meet interest expenses in future. After scouting for a buyer for its cement business, it eventually stuck a deal with Ultra Tech to buy JP’s five operating units of capacity 17.2 MT and a grinding mill for Rs 16189 crore and Rs 470 crore respectively. This will reduce JPA’s debt by almostRs 16000 crore. After the deal clinched with Ultra Tech, JPA’s debt will be reduced to Rs45284 crorein upcoming quarter on consolidate basis. We estimate that the company’s interest cost will be Rs 5434 crore for FY17, down by 28% vs the interest payment in FY16. This will positively impact the earnings by Rs1400crore (post tax impact) and also considerably reduce the losses. Jaypee’s real estate arm has also been trying to sell some of its land and other assets for a while now. A further reduction of debt can lead to positive earnings going forward.

On the above basis we decided to find out companies which have seen the largest reduction in interest cost over 2016.

We analysed further to understand the companies which in FY16 were able to reduce debt substantially thereby interest cost and also increase theirbottom-line. We see from the table below that Sterlite Technologies has been able to reduce interest cost by more than 65% which led to its earnings turning positive. On similar lines we see United Spirits and SuzlonEnergy turning profitable post reduction in debt.

We all know that debt woes of infrastructure, manufacturing, cement andconstruction sectors are becoming talk of the town because of their scary lookingbalance sheets. Consortium lenders are reviewing such companies’ performances and want to take a call on debt restructuring. To understand which companies can perform better in FY17, we looked at companies which have substantially reduced debt in 4QFY16. The interest cost reduction and eventual positive impact on net income will start seeping in from FY17.

We have sorted out top such companies which have reduced their debt on standalone basis in fourth quarter of FY16 over previous quarter in same period. Out of these, 13 companies have given positive returns and 4 have failed to attract investors even after debt reduction. PNC Infratech which has shown rise in EBITDA by 23 per cent in Q4FY16 Vs Q3FY16 gave 12-month return by 39.11 per cent. Kakatiya Cement Industries and Ajmera Realty and Infra India have reduced debt in the range of 46 per cent to 49 per cent.

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TAKEAWAY:

Legend investor Warren Buffet once said, “It’s not debt per say that overwhelms an individual corporation or country. Rather it is a continuous increase in debt in relation to income that causes trouble.”Amida monetary logjam, higher interest cost affects the margins and overall financials, especially when the companies fail to generate enough profits. As of late, Indian companies have been reducing their debt levels trying to improve their financial performance and credit profile. They are taking actions to accomplish this. They are auctioning off their assets in order to lower their debt which in return will enhance their financial performance. Nonetheless, challenges remain as using the asset sale route to deleveraging has tendency to be tedious. In the recent times, aggressive approach adopted by the lender and bankers to recover debt from Indian corporate have resulted in the promptness and eagerness of Indian corporates to reduce debt and this in turn has turned to be a blessing in disguise as it’s a win-win situation for both the parties and certainly a good time for the shareholders/investors as well.