Debt reduction key for revival of the Ashok Leyland stock

The falling interest coverage ratio is a worry. From a comfortable 3.5 in the first half of the last financial year, the ratio has fallen to 0.65 in current year. Photo: Ramesh Pathania/Mint

Live Mint : R Sreeram : 7 Nov 2013

Best thing management can do now is conserve earnings by reducing debt, which is eating into operating profit

Ashok Leyland Ltd reported a weak performance for the September quarter. Sales fell 23% and the company plunged into a loss as high discounts and raw material costs hit margins.

Considering the sharp fall in volumes, the losses did not come as a surprise. What was a surprise though was the sharp rise in debt and finance costs. In June, the company had said it was planning to lower debt by Rs.500 crore by reducing working capital loans by the end of the current fiscal year. This led to the fond belief that finance costs would edge down.

Contrary to these hopes, total borrowings jumped 39% to Rs.4,894 crore, leading to a 20% rise in finance costs. According to Nomura Research, working capital increased by Rs.380 crore in the first half of the current fiscal year.

The sharp rise in borrowings and finance costs unsettled analysts. But at 1.3 times, the debt to equity ratio is manageable. The company is looking to restrict capital expenditure, reduce working capital and sell more non-core assets in the next few months. In a conference call with analysts, the management said it is aiming to raise Rs.700-1,000 crore and will use the amount to repay debt. Still, the comments did little to soothe investors. The stock plunged 5% on Thursday.

The worry is the falling interest coverage ratio. From a comfortable 3.5 in the first half of the last financial year, the ratio has fallen to 0.65 in current year. That suggests the company’s operating cash flows are insufficient to service the finance costs.

The outlook for the core business, meanwhile, continues to be dim. Sales are sluggish. To woo customers, manufacturers are stepping up discounts. From an average of Rs.1.65 lakh per unit in the last quarter, discounts have risen to Rs.1.75 lakh per unit now. High discounts can weigh on realizations. With raw material costs inching up (especially steel), analysts fear that margins and operating profits will continue to be under pressure for the rest of the fiscal year.

These concerns are leading to reduction in earnings estimates. With sales showing no signs of revival, some broking firms like IDBI Capital Market Services Ltd have cut their volume and margin estimates for the next fiscal year as well. Overall, with the outlook for the core business not encouraging, the best thing the management can do at this stage is to conserve earnings by reducing debt, which is eating into operating profits.