The Atlases
We have analysed 7 over-leveraged companies. Find out what are problems and how to avoid them
By Vikas Vardhan | Aug 11, 2017
In Greek mythology, Atlas was a Titan who held the sky. In modern times, perhaps his counterparts are companies which are heavily leveraged. Leveraging means borrowing money to improve profitability by investing it, often in some big-ticket avenues. But leverage is also a double-edged sword. If it fails to produce profits, it can even lead to big losses on account of payment of interest and principal. Adverse market conditions and a reversal in the market cycle can further lead to spiralling problems for over-leveraged companies. Since borrowers have a superior claim on a company's profitability and assets, high leverage can create a deficit for equity owners.
How can you find over-leveraged companies? A simple measure of the level of debt is the debt-to-equity ratio. In this section, we present to you some companies that have a high debt-to-equity ratio, coupled with a low return on capital employed (ROCE). This means that not only are these companies heavily in debt, they aren't making much on their invested capital. Great companies thrive on the soundness of their business, not leverage. Consider the Sensex. Its constituents, barring three, have never had a debt-to-equity ratio of more than two.
Aban Offshore
Aban Offshore is an offshore drilling-services provider. The company had taken loans of Rs 13,000 crore against a net worth of just Rs 506 crore at the market peak of 2008. A debt-to-equity ratio of more than 16 times made it too fragile a company. It had a dismal return on capital of less than 7 per cent. This was a result of a big expansion plan. The company did generate profits, but they remained stagnant. High interest costs left little for the equity holders.
Aban Offshore is an offshore drilling-services provider. The company had taken loans of Rs 13,000 crore against a net worth of just Rs 506 crore at the market peak of 2008. A debt-to-equity ratio of more than 16 times made it too fragile a company. It had a dismal return on capital of less than 7 per cent. This was a result of a big expansion plan. The company did generate profits, but they remained stagnant. High interest costs left little for the equity holders.
HCC
Hindustan Construction Company operates in the engineering and construction space. Bullish on the future, the company raised huge debt for its projects. But business cyclicality and delays in its landmark project Lavasa hit its revenues and thus profitability. It has been a loss-making company for a long time. Even before the 2008 crisis, when business sentiment was quite bullish, the company had a poor return on its investment, of less than 10 per cent.
Hindustan Construction Company operates in the engineering and construction space. Bullish on the future, the company raised huge debt for its projects. But business cyclicality and delays in its landmark project Lavasa hit its revenues and thus profitability. It has been a loss-making company for a long time. Even before the 2008 crisis, when business sentiment was quite bullish, the company had a poor return on its investment, of less than 10 per cent.
Jaiprakash Associates
Jaiprakash Associates is into cement, construction, power, real estate, fertilisers and many more businesses. In the last financial year, the company had around Rs 70,000 crore debt against net worth of Rs 12,891 crore and a market cap of just `3,617 crore. It has remained highly indebted for a very long time. Even when it was witnessing good times till 2008, it had a debt-to-equity ratio of more than three. Its ROCE was 13 per cent, which is not safe for a cyclical business.
Jaiprakash Associates is into cement, construction, power, real estate, fertilisers and many more businesses. In the last financial year, the company had around Rs 70,000 crore debt against net worth of Rs 12,891 crore and a market cap of just `3,617 crore. It has remained highly indebted for a very long time. Even when it was witnessing good times till 2008, it had a debt-to-equity ratio of more than three. Its ROCE was 13 per cent, which is not safe for a cyclical business.
Kingfisher Airlines
Kingfisher had been a loss-making entity since the day it started trading on the stock market, in 2006. Yet the company took on more debt, taking its debt-to-equity ratio to over two. As losses mounted, debt kept on accumulating. The business couldn't be revived and instead of changing the business strategy, the promoters kept waiting for good times, which, in their case, never came.
Kingfisher had been a loss-making entity since the day it started trading on the stock market, in 2006. Yet the company took on more debt, taking its debt-to-equity ratio to over two. As losses mounted, debt kept on accumulating. The business couldn't be revived and instead of changing the business strategy, the promoters kept waiting for good times, which, in their case, never came.
Reliance Communication
Reliance Communication, an Anil Dhirubhai Ambani group company, is the latest entrant to the loan defaulters’ club. The company has sought time till December 2017 to repay its debt. Its debt-to-equity ratio, which is below 1.5, doesn’t look too bad. But its ROCE, which averaged 4 per cent in the past five years, is too low to service debt for a long time. Total consolidated debt stands at Rs45,000 crore as per the latest filings. The business has taken a hit due to the fierce competition in the telecom sector and due to the coming of Reliance Jio.
Reliance Communication, an Anil Dhirubhai Ambani group company, is the latest entrant to the loan defaulters’ club. The company has sought time till December 2017 to repay its debt. Its debt-to-equity ratio, which is below 1.5, doesn’t look too bad. But its ROCE, which averaged 4 per cent in the past five years, is too low to service debt for a long time. Total consolidated debt stands at Rs45,000 crore as per the latest filings. The business has taken a hit due to the fierce competition in the telecom sector and due to the coming of Reliance Jio.
Videocon
Videocon was mainly into consumer electronics and then it diversified into highly unrelated businesses like power and oil exploration. The management says it wants to be an oil and energy company in the coming times. To fulfil this ambition, the company has also raised huge debt, which currently stands around Rs50,000 crore. But then the company defaulted on its loan due to a slump in the oil sector. Banks are increasingly classifying Videocon’s debt as non-performing.
Videocon was mainly into consumer electronics and then it diversified into highly unrelated businesses like power and oil exploration. The management says it wants to be an oil and energy company in the coming times. To fulfil this ambition, the company has also raised huge debt, which currently stands around Rs50,000 crore. But then the company defaulted on its loan due to a slump in the oil sector. Banks are increasingly classifying Videocon’s debt as non-performing.
Suzlon Energy
Suzlon Energy is in the business of wind-power generation and it also manufactures and installs equipment for that. Suzlon was ahead of its time. Looking at the bright future for renewable energy, the company aggressively acquired many companies overseas. It raised debt in the process. But the acquisitions did not work. Suzlon’s debt has soared year on year, except for the last year. Its return on capital has largely remained negative or insufficient to cover debt repayments.
Suzlon Energy is in the business of wind-power generation and it also manufactures and installs equipment for that. Suzlon was ahead of its time. Looking at the bright future for renewable energy, the company aggressively acquired many companies overseas. It raised debt in the process. But the acquisitions did not work. Suzlon’s debt has soared year on year, except for the last year. Its return on capital has largely remained negative or insufficient to cover debt repayments.
Avoiding Atlases
In general, avoid companies which are highly leveraged and at the same time are not able to earn more than what they have to spend on their borrowings. To be precise, stay away from companies with debt to equity of more than two. Even if it is lesser, make sure the company earns a high ROCE so that it can service the debt on time. If the ROCE is low, then the company will have to take on more debt to service its past loans.
In general, avoid companies which are highly leveraged and at the same time are not able to earn more than what they have to spend on their borrowings. To be precise, stay away from companies with debt to equity of more than two. Even if it is lesser, make sure the company earns a high ROCE so that it can service the debt on time. If the ROCE is low, then the company will have to take on more debt to service its past loans.
Another measure to assess the degree of leverage is the interest-coverage ratio. It is calculated by dividing the profit before interest and taxes by interest expenses. The higher the interest-coverage ratio the better it is. Go for companies with ratios of more than two times.
One more effective tool is the Altman Z-Score. A score of less than three indicates likelihood of default and should call for a thorough investigation. To know more about the Altman Z-Score and check the score on any stock, log on to www.valueresearchonline.com and search for that company. See the Essential Checks section on the right side.
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