Buoyant market means little for over-leveraged firms

Last Updated: Sat, Sep 29, 2012 07:20 hrs

Markets are rallying and investors have renewed their love for cyclical stocks, but it is still a long road ahead for companies that want to use the buoyancy to deleverage their balance sheets.

There is still a huge gap between market values and accumulated debt of most companies in the infrastructure, power, oil & gas, sugar and metals sectors, among others (see table). For instance, Adani Enterprises, the flagship company of the Adani group, reported a net debt of Rs 62,600 crore (on a consolidated basis) as on March 31, 2012, which is nearly thrice its current market capitalisation. This is despite a nearly 30 per cent rally in the company’s stock price over the past month.

The debt-to-market-value ratio is even higher for Lanco Infra (7.4), GVK Power & Infra (5.3), Videocon Industries (4.6) and Hindustan Construction (5.6).

As a company’s market value determines its ability to raise equity by issuing new shares and retire debt, large gap between these firms’ market cap and debt shows their trouble is far from over. This is because even if some of these firms dilute their equity by 100 per cent, the amount raised will make up for only a small portion of their debt pile. In a normal course, however, equity issuance is always a fraction of the company’s existing equity capital.

Investment bankers, however, say the rally has come as a big relief for companies. “The rally has helped and we are now receiving many enquiries from companies that wish to raise fresh equity — including one from the infrastructure sector,” says Dara Kalyaniwala, vice-president, investment banking, at Prabhudas Lilladher. He, however, adds that action on the ground will happen only if the rally sustains for a few months more.

According to him, highly indebted firms can at best hope to retire only a fraction of their total debt by raising new equity capital. He also rules out a flood of hybrid instruments, such as foreign currency convertible bonds, where companies play on the rise in stock price in future to raise money in the present. “Investors are not willing to pay more than 10 per cent premium to a company’s prevailing stock price for an instrument converting into equity 12-18 months from now,” he says.

That being the case, companies may be forced to look inwards if they want any meaningful reduction in their bloated debt. This means improving internal cash generation or raising cash by selling some of assets. But this will mean putting brakes on growth plans for now.

Not surprising, many analysts and investors are sceptical of the current rally and remain invested in companies with little or no balance sheet issues. “Nothing has changed in recent weeks to warrant a change in long-term investment strategy. We are still bullish on companies with strong balance sheets and staying away from over-leveraged ones,” says Dhananjay Sinha, co-head, institutional research, Emkay Global Financial Services.

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