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Illustration: Kishore Das


Debt drain
A few companies have managed to overcome their leverage blues

Jitendra Kumar Gupta

Borrowing from the future can be a tricky decision, especially when you have no way to tell which way the tide will turn. In the financial markets, debt financing is one such double-edged sword that can hit investors hard during downturns but can equally become beneficial during a recovery. Today, this sword has turned in favour of those who have attempted or managed to beat the debt trap. Though most companies are still struggling, some of them have been able to emerge out of the current crisis, partly thanks to asset monetisation, industry recovery and some key financial measures. So, what does this mean for investors? Well, if successful, some of these companies will actually be able to offer huge opportunities to investors, as lower debt and interest costs will not only have a positive rub-off on earnings but could also mean huge gains through valuations rerating. Currently, most such companies show depressed earnings because of the negative impact of leveraging in terms of interest costs, creating a vicious cycle where investors currently are afraid of taking a chance on the stocks given the amount of debt on the books, thereby impacting valuations. 

Making a strong comeback

Delivering has also translated into better return ratios for the four companies

“Most investors value these companies based solely on their enterprise value, which is a measure of debt plus equity. Reducing the debt or eliminating it altogether will be a good sign for equity shareholders as valuations will then start to tilt in their favour,” says Saurabh Mukherjea of Ambit Capital. But emerging out of debt is not that simple, offers Nirmal Gangwal, founder and MD, Brescon Corporate Advisors. “There are very few companies that have been able to come out of the debt trap. Those who have done well have managed to stay away from debt since, despite the concerns of the banking system. Though this could be a good sign for equity shareholders, they need to be vigilant while evaluating such turnaround cases and confirm whether the companies have a reasonably liquidity position. They also need to keep a close watch on the industry scenario and the business environment as these factors can sometimes drag companies back into debt. While poring over coverage ratios and cash flows, investors also need to check how sustainable the company’s ability to service debt is.” 

While there is a need for caution, following are four companies that have been able to improve their performance and emerge out of debt, thereby giving their shareholders an edge over their borrowers.

 Aban: Slick affair

Just managing its debt would not have helped India’s largest offshore service provider Aban Offshore. Instead, a timely recovery in business and the industry helped matters. A revival in demand, better realisations and its efforts to cut debt have now started showing results. Aban’s ratio of debt to equity soared to 6.30 times in recent times, before falling to 3.8 times by the end of March 2014. Importantly, Aban’s ability to service debt has improved, with its interest coverage ratio improving to 1.5 times in FY14 from 1.3 times the year before. That apart, it has refinanced its debt for a longer tenure of 15 years, which helped in lowering the pressure on its annual bullet payments at a time when liquidity was a huge issue. Thankfully, a longer payment cycle and improving cash flows from operations — ₹258 crore in FY12 to ₹423 crore in FY14 — are helping the company tide over the crisis. Converting all its loans into dollar denomination also helped Aban in lowering interest rates, thus protecting its loan exposure from currency volatility and serving as a natural hedge. “FY14 was a decisive year for us, with the company reflecting a significant improvement in its performance, both physically and financially. This performance has also signaled that the company has overcome a sectoral hump and is poised for better days. Aban has successfully deployed almost all its rigs on contract, resulting in high asset utilisation,” said managing director Reji Abraham.

The recovery in rig utilisation and day rates will prove to be a kicker

Aban has 18 rigs in its portfolio, which are deployed around the world and in the domestic market for companies such as ONGC. After the 2008 crisis and fall in crude oil prices, the global demand for rigs had shrunk and day rates — or rentals — had tumbled. However, from lows of about $90,000 a day, the rates have recovered to over $124,000 a day. Asset utilisation levels has improved over the past three years, helping Aban enjoy economies of scale. Aban’s operating profit margin has improved from 55% in FY13 to 57% in FY14 and 59% in the June quarter of FY15. So far, the going has been good for Aban, but for the company to emerge out of the debt trap, the industry environment must improve, as a large number of its offshore assets will come up for renewal in 2015 and 2016. “In the future, the company expects to report an increase in earnings, which are not driven as much by an increase in day rates as by a decline in interest,” sums up Abraham.


Gati: On a roll

Leading logistics services provider Gati’s prospects have taken a hit due to the ₹450 crore debt on its books. Though the company’s sales grew at 13% over the past four years, its debt was 1.7 times its equity capital. Gati’s ability to service debt, particularly in the light of non-core businesses being under pressure, also came under question.

 Traction in new businesses is likely to result in better operating margins

However, things are changing for the better. Recently Gati has hived off its highly capital-intensive shipping business — which was going through a downturn and making losses — while divesting a 40% stake in a separate subsidiary. Gati transferred its express distribution and supply-chain business into a joint venture with Japanese firm Kintetsu World Express, which bought a 30% stake for ₹268 crore. Due to these initiatives Gati not only retained control over its working capital but also managed its debt and liquidity position. This would improve even more as Gati reduces its debt while diluting a bigger stake in the shipping business. “Our FCCB will be repaid through the sale of large land parcels which we will initiate when we get better prices,” says Sanjeev Jain, director, finance, Gati.

 Gati now wants to focus more on growing businesses such as e-commerce, express cargo and cold chain logistics. These businesses fetch higher margins, which are critical for its profitability and earning in the future.



Jain Irrigation: A bumper harvest

Jain Irrigation, the largest player in the micro irrigation space, has been able to cope with its debt problem as its efforts to reduce dependence on working capital and manage receivable days have started yielding results.

In the past, the company had accumulated a huge amount of debt because of delays in the payment of government subsidies on the micro irrigation systems (MIS) solutions that it supplies to farmers, which led to an increase in receivables. The MIS business gross receivables have come down from 369 days in FY11 to 257 days in FY14 and further to 235 days in the June 2014 quarter.

The cash-and-carry model has drastically reduced gross receivables


A large part of this change could be attributed to a change in business model, as the company now follows a cash-and-carry model, whose benefits are yet to fully reflect on its books. In a note prepared for Axis Capital, analyst Hemant Patel says, “The management is targeting a further 45-day reduction in receivables in FY15, as the full benefits of the cash-and-carry model play out. We expect working capital-to-sales to decline to 39% in FY16 from 61% in FY13 and 50% in FY14.”

“We have shifted to a cash-and-carry model, where the subsidy part is now taken care of by farmers itself, which is why our concern over receivables is now easing. Our gross receivables have fallen from ₹2,500 crore in FY12 to ₹1,600 crore currently, despite growth in revenues. Additionally, we have maintained strict control on inventory and capex, which has helped us manage our debt effectively,” said Anil Jain, managing director, Jain Irrigation.

Moreover, a reduction in receivables has resulted in higher cash at the company’s disposal (about ₹800 crore-900 crore), which it is now using to fund its business growth, instead of just relying on borrowed funds. Case in point: in FY14, the company generated about ₹930 crore from operations, as against ₹346 crore in FY13. 

Its core MIS business — where Jain Irrigation is the largest player with a 55% market share — has been growing at a rapid pace due to low penetration and the government’s emphasis on micro irrigation. As the company is now able to fund its growth from the internal accruals, the management believes that they now have the opportunity to grow much bigger. Higher growth will have a huge impact on the company’s earnings, which are currently depressed because of interest costs. Incremental growth in revenue will reflect directly on earnings. For instance, as against an EPS of ₹1.4 in FY14, the company is expected to report an EPS of ₹6 in FY15 and ₹11 in FY16. More importantly, due to the improvement in earnings, return ratios such as return on equity are expected to improve. This will be a key catalyst for Jain Irrigation’s share prices as the market tends to give a higher valuation premium for companies that show better return ratios and manageable debt. 


Ceat: Clocking a good mile

Ceat, the leading player in the domestic tyre industry, has managed to ease investor concerns over its rising debt. “Around 2011-2012, we were hit hard because of the sudden jump in raw material (rubber) prices from ₹80/kg to ₹140/kg. We had also incurred a large capex for our manufacturing unit in Gujarat, where the benefits of production ramp-up were yet to be seen. Thankfully, raw material prices have come down, production has ramped up and due to our focus on a profitable product mix, we have been able to generate good cash flows and earnings,” says Anant Goenka, managing director, Ceat.

Ceat now has a good presence in the high-margin UV and 2-wheeler segments

A changing business mix, focus on exports and improvement in margins has led to better days for the tyre major. “Since FY10, Ceat has significantly increased its focus on high-margin segments (two-wheelers, passenger vehicles, specialty tyres) and has gained market share in the domestic two-wheeler and utility vehicles segments (up from 8% and 0% to 22% and 14%, respectively, in the past three years), even as domestic auto demand struggled. Increasing exposure in these segments helped revenue (18% annual growth) and operating performance (21% annual growth in Ebitda) over FY10-14. We expect the trends to continue as Ceat transforms itself into a more focused, profitable entity,” says analyst Ambrish Mishra, who tracks the company at JM Financial Institutional Securities, in a research note.

A better revenue mix and margins are now helping the company generate higher cash flows — annual cash from operations has improved from a mere ₹6.7 crore in FY12 to ₹557 crore in FY13 and ₹155 crore in FY14 — and improved its liquidity and ability to service debt. “Metrics have continued to improve on the debt side. Our overall short- and long-term debt equity stands at 1.1, as against 1.3 in the previous year, despite the increased operations and working capital requirements. Our interest to Ebitda ratio is also four times and our debt service coverage ratio is more than two times,” company spokespersons said during a recent analyst conference call. Worries on the debt front are easing at a time when the business outlook is improving, given the increased focus on exports and high-margin businesses. The company has a 40% market share in Sri Lanka, which it further intends to replicate in countries such as Bangladesh. For instance, the contribution of non-truck revenues has risen from about 40% in 2011 to 52% in FY14, which is helping net higher margins and earnings.   

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