Neck deep in debt

BL Radhika Merwin 3 Sep 14

India Inc's debt has been rising at an alarming rate. Yet, it hasn’t translated into productive assets for many. Read about the companies that are sinking and those that are sailing merrily

Recently, steelmaker Bhushan Steel was in the news after the company’s Vice-Chairman and Managing Director was arrested on charges of bribing the Syndicate Bank chief to extend fresh loans to it and prevent the bank from declaring the company’s existing loans as delinquent.

A forensic audit has now been ordered into the company’s books to verify if the borrowed money was used for the right purposes.

But don’t dismiss this as a one-off incident. Many members of India Inc are in much the same boat as Bhushan Steel, not in terms of corruption charges, but on the state of their finances which triggered this episode.

The issue of banks continuing to extend loans to over-leveraged companies has become a systemic concern. Debt at leveraged companies as well as the banks’ stock of bad loans have been rising at a scorching pace in the last five years.

The great divide

In the boom years of 2008 to 2010, Indian companies, fresh out of the credit crisis, lined up aggressive expansion plans believing that the uptick in the economy would stretch on for a while.

Firms in the core sectors of the economy took on significant loans to fund a ramp up in capacities for steel, mining, power generation and infrastructure projects.

But as the revival gave way to a renewed downturn, the rosy projections went awry. Policy and judicial activism and lack of raw materials also stalled a number of big-ticket projects midway, locking up funds of many large corporates in the core sectors.

Consider this. In the last five years, long-term debt of 966 NSE-listed companies has simply soared, growing by about 30 per cent annually. But fixed assets of these companies — to augment which these funds were raised in the first place — have grown by just 15 per cent during the same period.

The growth in debt has been particularly sharp between 2007 and 2008 and 2011-12, when it grew by almost 40 per cent annually. But growth in fixed assets slowed down considerably from 29 per cent in 2008-09 to 13-19 per cent in the subsequent years.

This also ties in with the findings of the Economic Survey. When India’s economy was firing on all cylinders between 2003 and 2008, capital spending by the corporate sector kept pace. But post-2008, corporate investments as a proportion of GDP have fallen to 9 per cent from 14 per cent during the boom phase of 2005 to 2008.

Studying the balance sheets of firms, it is clear that only half of the long-term funds raised every year were actually used for purchase of fixed assets since 2009. It is hence no surprise that some companies with huge debt are struggling to meet interest obligations — the slow pace of addition to capacities has meant that cash flows haven’t kept up with interest obligations. This has hit the profitability of these companies.

Infrastructure, iron and steel, mining and textiles sectors had the most stalled projects, and the difference between growth in loans and fixed assets is more pronounced in these sectors.

Here’s a look at these troubled sectors in detail.

Infrastructure in a debt spiral

Infrastructure is one of the sectors that contributes significantly to the level of stressed loans within the banking industry. About 18-20 per cent of the total loans given to this sector are under stress (bad loans and restructured assets).

Policy uncertainties stemming from difficulties in land acquisition, delayed environmental clearances and infrastructure bottlenecks have stalled many projects and shrunk the cash flows of companies burdened by debt. This reduced capital expenditure down to a trickle.

Our sample reveals that the construction and infrastructure sector has a 14 per cent share in the total long-term debt pie of India Inc. While long-term loans extended to this sector grew by about 44 per cent annually in the last five years, the growth in fixed assets has been much lower at 27 per cent.

In the last two years, the addition to fixed assets has been even slower — 18 per cent in 2012-13 and 8 per cent in 2013-14.

While investors have been gung-ho about the new Government’s pro-business agenda, and driven many infrastructure stocks up in the recent rally, the poor state of finances of some of the companies within the sector doesn’t support this optimism.

While most companies within the infra space have a high debt-to-equity ratio (DER), there are some worse-placed than others.

Take for instance, GVK Power, GMR Infra and JP Associates. Each of these companies has a high DER of five-seven times, and added debt at a much faster pace than fixed assets. GVK Power Infrastructure’s long-term debt has risen seven-fold from 2008-09, while fixed assets have expanded only four-fold.

More worrying, the company’s interest cost has risen about 30-fold from 2008-09, and the company has reported losses at the PBT (profit before tax) level for the second year in a row.

JP Associates has seen its interest cost shoot up by 50 per cent annually in the last five years. Gayatri Projects, Era Infra, IL&FS Transport, and Hindustan Construction are others that have added debt at a much faster pace than fixed assets. Hindustan Construction saw its long-term borrowings grow by about 31 per cent annually since 2009, but its fixed assets grew by 20 per cent.

A quick turnaround in most of these companies is unlikely, given that they are struggling to pay off their older debt obligations. As the companies struggle to complete existing projects, they may face difficulty in adding to their order books by participating in new bids.

However, there are a few infra companies that have managed to contain their debt burden. L&T and Adani Ports have DER of less than two times, and their growth in debt more or less ties in with the asset growth.

Sadbhav Engineering and IRB Infra too have been able to grow their assets 30-40 per cent annually over the last five years in tandem with the growth in debt. While their DER isn’t low at three to four times, both score on order book and execution strength.

Power in for a long haul

Power is another sector that is neck deep in debt. This sector constitutes a fifth of the total long-term loans with India Inc. The debt extended to this sector has grown 31 per cent annually since 2008-09. Fixed assets have however grown by just 20 per cent. The sector’s problems range from lack of fuel to power up plants to un-remunerative tariffs. As a result, many companies have been unable to service their debt obligations.

While Lanco Infratech saw its long-term debt and fixed assets grow by 46 per cent annually in the last five years, it had a debt equity ratio of 24 times in 2013-14.

Recently, the company sold its thermal power plant to Adani Power to trim its debt. While this will help repay some of its huge debt, the sale effectively deprives it of a primary cash-generating asset. This may not augur well in the long term.

There are others such as Adani Power and KSK Energy Ventures that saw their loans grow 45-65 per cent annually since 2008-09. Their fixed assets grew 40-50 per cent.

Most power plants have been operating below production capacity due to lack of availability of coal and gas needed to run these plants. Policy action from the Government to fix the problem of fuel shortage can help kick-start coal- and gas-fuelled power projects.

However, there are a few companies in the power sector that are better placed. Torrent Power, for instance, has a DER of 1.4 times. Its debt has grown by 22 per cent annually in the last five years, while fixed assets have grown by 19 per cent.

JSW Energy is one other player that has a DER of 1.4 times, and its long-term debt has grown by just 9 per cent annually in the last five years.

While Reliance Power scores well on a lower DER (1.4 times) , that the company’s loans have grown by 87 per cent in the last five years against 56 per cent growth in fixed assets may need a watch.

While Tata Power has a higher DER, its debt has grown by a moderate 18 per cent in the last five years backed by 16 per cent growth in assets. The recent Supreme Court order declaring all allocations of coal blocks since 1993 as illegal is likely to exacerbate the shortage of fuel for power plants in the short term.

Metals and power companies that depend on coal to run smelters and generate electricity may be in for a rough ride. It may be best to avoid power stocks for now, particularly ones that have a huge debt burden, till more clarity emerges on the recent order.

Hard times

With the Bhushan Steel episode, steel manufacturers, mining and metal players are suddenly at the centre of the debt maelstrom. Bhushan Steels’ long-term debt is now more than thrice the levels in 2008-09. While the company has grown its fixed assets too, delay in commissioning these capacities has led to the company struggling to meet debt obligations.

Interest costs have shot up by 45 per cent annually in the last five years, while its profit before tax is less than a fifth of that reported in 2008-09.

Electrosteel Steels, which has a DER of more than five times, has seen debt grow 41 per cent annually since 2010 (IPO in 2010), compared to 29 per cent growth in fixed assets. The company has been reporting losses at the PBT level since its IPO.

JSW Steel and Tata Steel, however, are better placed within this pack. Both have a DER of less than two times. JSW Steel’s debt and fixed assets have grown at 16-17 per cent annually in the last five years. Tata Steel’s debt grew at a modest 1 per cent in the last five years, while fixed assets have grown by about 9 per cent during the period.

The recent order on coal allocations is likely to impact mining companies. Post the recent order, companies such as Jindal Power and Steel, Hindalco and Sesa Sterlite may be the worst impacted.

Other sectors to watch for

The aviation sector has been another big source of stressed loans for banks, but for very different reasons.

High aviation fuel cost, weak passenger traffic leading to price discounts, high aircraft maintenance costs and airport charges have seen airline players incur huge losses.

After taking a big knock on the loans given to the ailing Kingfisher Airlines, banks are also grappling with credit extended to other players. The poor performance of Jet Airways in 2013-14 has only eroded its net worth further, which is a negative ₹4,175 crore.

Many key sectors and stocks mentioned above have rallied on hopes of a revival and expectations of reforms. But it may be best to avoid companies with weak finances.

These companies are likely to focus on trimming their debt, when earnings recover with the economy — rather than invest aggressively in new projects.