Firms selling assets to cut debt are good investment
Many domestic companies (mostly midcaps and small-
caps) are selling assets and raising equity to pay off
debt. While the process has been on for some time, it
has gathered momentum of late due to improvement in
demand for industrial assets and rise in equity markets,
which are ensuring that companies get good value for
their assets.
Companies that have sold assets/new shares or plan to
do it in the near future include Reliance
Communication, Tata Steel , Jaiprakash Associates,
Videocon and Ashok Leyland.
According to a Crisil report published on July 7, in the
past 18 months, a total of 21 companies have
announced 36 deals to sell assets/equity to raise Rs
80,000 crore, which is nearly a fifth of their debt.
“Expected policy reforms and buoyant capital market
should lead to more such transactions. We expect
companies to raise at least another Rs 60,000 crore in
2014-15,” says the report.
Falling debt is good for a company’s stock as it
improves profitability by freeing up funds. So, as more
and more companies line up to sell assets/equity,
investors have an opportunity to make good money by
buying their shares to cash in on a likely recovery.
HOW DEBT HITS PERFORMANCE
Suzlon Energy, a wind power generator, had a market
cap of Rs 50,000 crore at the start of January 2008.
The stock rose 192% from Rs 97 on 29 December 2006
to Rs 284 on 31 December 2007.
The same year, it started the process to acquire
REpower, a German wind power company. It completed
the acquisition in 2011. This proved to be expensive for
Suzlon by making it borrow heavily. Its debt jumped 10
times from Rs 450 crore on 31 March 2006 to Rs 5,162
crore a year later. The interest cost increased from Rs
65 crore to Rs 276 crore during the period.
At the end of 2012-13, the consolidated debt stood at
Rs 15,190 crore while interest cost was Rs 1,800 crore,
more than its operating profit (sales minus expenditure)
.
The stock, which was at Rs 284 at the end of 2007,
was at Rs 21.50 on July 30, down 92.5% in the past
sixand-a-half years. The company’s market cap shrunk
from Rs 50,000 crore in January 2008 to Rs 6,000 crore
on 31 July 2014.
This is not a one-off case. Over-leveraging has led to
sharp deterioration in finances of a number of
companies. This is especially true after the 2008 global
financial crisis, which lowered India’s economic growth
and made sure that many companies found it difficult
to service debt due to shrinking sales and margins.
Total debt of companies in the BSE 500 index
(excluding banking and finance companies) was Rs 4.5
lakh crore on 31 March 2007. It rose five-fold to Rs 20
lakh crore till March 2013. The interest paid rose from
Rs 22,000 crore to Rs 1.2 lakh crore.
Among the companies discussed above, as many as 68
(out of 400) have a debt-to-equity ratio of more than
two, which means their borrowings are double their
equity capital.
Many of these debt-ridden companies were once hailed
as emerging stars (Suzlon Energy, GMR Infrastructure,
GVK Power and Infrastructure, Jaiprakash Associates)
on the corporate horizon. However, many are now
struggling to service their debt; some are on the verge
of insolvency. Many have opted for corporate debt
restructuring, or CDR , under which banks ease the
debt’s terms and conditions (reduction of interest rate
and increase in tenure).
“There has been a sharp rise in the number of
companies opting for CDR in the past few years.
Approved cases under the CDR mechanism, which
caters to roughly 30% stressed debt in the country,
have reached $60 billion, up 50% from last year,” says
Aman Chowdhury, chief executive, Cians Analytics.
Banks have also started facing the heat as companies
show inability to service debt. The net non-performing
assets, or NPAs, of commercial banks rose from Rs
19,000 crore in 2007 to Rs 94,000 crore in 2013. That’s
why the strongest push to sell assets has come from
banks and other lenders.
WAYS OF RETIRING DEBT
Selling non-core assets seems to be one of the most
popular avenues to reduce debt. For example,
Jaiprakash Associates wants to sell non-core assets
such as a cement factory and some real estate
projects and thermal plants in 2014-15. A few months
ago, Tata Steel sold its land in Borivali, Mumbai, to
Oberoi Realty for Rs 1,155 core. GMR Infrastructure
has sold two road projects this year; it is also likely to
sell a 40% stake in Istanbul International Airport.
With the economy improving, companies are now
getting better value for their assets, which is a big
reason for the spike in the number of such deals.
“It’s easy to get rid of high-cost assets when they are
fetching a good price. Probably it is difficult for these
companies to earn a good return on these assets and
so they might as well sell them,” says Deepak Shenoy,
founder, Capitalmind, a research firm.
Another route for raising money to retire debt is sale of
equity. Here, the company issues new shares through
follow-on offer, private placement or offer for sale or
OFS. The promoter’s shareholding falls.
Recently, Reliance Communication raised Rs 4,800
crore by selling fresh shares. A part of the proceeds
will be used to reduce debt, which stood at Rs 40,000
crore at the end of March. Similarly, Hindustan
Construction Company plans to raise Rs 750 crore
through private placement of shares.
With sentiment in equity markets turning positive and
investors’ risk appetite increasing, we may see a flurry
of such equity issues. The Securities and Exchange
Board of India has also eased norms for companies
taking the OFS route.
The other ways of reducing debt are bringing in
strategic investors at the project level, sale &
leaseback and securitisation of receivables.
IMPACT ON STOCK PRICE
Debt is fine as long as the interest rate is less than
what the company is earning from its assets. As
interest rates rise and the company’s return on assets
goes down, interest payments can substantially bring
down profit margins.
When a part of the debt is paid back, the total interest
paid comes down and margins rise. This results in re-
rating of the stock.
“As companies reduce debt from extreme levels and
improve their debt-equity ratio, investors get
confidence in their ability to service debt and deliver
returns. For example, the recent issue by an oil
services company, which led to 25% equity dilution, to
repay high-cost debt translated into a 25% improvement
in earnings, driven mainly by savings in interest
payments,” says S Krishna Kumar, head of equity,
Sundaram Mutual Fund.
Rs 80,000 crore is the value of assets/equity sold by
21 companies in the past 18 months, according to
Crisil
Rs 60,000 crore is the worth of assets/equity likely to
be sold in 2014-15
Valuations fall when debt increases without a
commensurate rise in return on assets. So, when a
company reduces debt, its valuations generally rise as
investors factor in an improvement in fundamentals and
reduced solvency risk.
“Try to understand it from the perspective of enterprise
value, which is market cap plus debt minus cash. If a
company has a market cap of Rs 2,000 crore and a
debt of Rs 10,000 crore, then its enterprise value is Rs
12,000 crore. If it retires a debt of Rs 5,000 crore, the
market cap (price*outstanding shares) may go up by
that much,” says Vinay Khattar, associate director and
head of research, Edelweiss Financial Services.
TAKE BETS CAREFULLY
Shares of companies that are selling assets or issuing
fresh equity to retire debt are good investments. This is
because their prices jump sharply after the
announcement. But the long-term performance of such
companies is in doubt.
The reason for this is that some companies selling
assets are heavily leveraged and the amount paid is
too small in comparison to the total debt to have any
meaningful impact on the stock over the long term. In
some companies, the debt could be purely because of
stuck projects. Besides, some companies are selling
cash-generating assets, which may impact their cash
flow, neutralising the impact of lower debt.
“For such companies (which are in debt due to stalled
projects), equity dilution will not alter the balance
sheet meaningfully. It makes more sense for these
companies to tap the market as and when confidence
in the macro environment improves and project
bottlenecks are cleared,” says S Krishna Kumar, head,
equity, Sundaram Mutual Fund.
Manish Gupta, director, Crisil Ratings, says, “The extent
of improvement in corporate credit profiles will be
limited because asset sale also reduces the operating
cash flow.”
According to him, more than 90% completed
transactions involved cash-generating assets. Even
after the sale of assets & equity, the debt-to-EBITDA
multiple of these companies is expected to improve
only marginally from nearly nine times as on 31 March
2014 to just below eight times over the next one year.
EBITDA is earnings before interest, tax, depreciation
and amortisation.
Khattar of Edelweiss says some of these companies
are good trading bets. But he says he will not advise
people to stay invested in these stocks for long.
With sentiment in equity markets improving and many
companies lining up share sales, it is to be seen if the
markets are able to absorb all these equity issues.
According to PVK Mohan, head of equities, Principal
Mutual Fund, investors have to be wary of the rush of
new equity offers. “They must buy only quality issues.”
RETIRING DEBT
– Suzlon Energy plans to raise about Rs 1,000 crore
from sale of non-core assets in 2014-15. It has already
raised more than Rs 700 crore by selling two non-core
assets.
– Jaiprakash Associates plans to sell Rs 10,000 crore
worth of assets in 2014-15. It has already sold assets
worth Rs 15,000 crore in the second half of the
previous financial year.
– Tata Steel has sold its Borivali land for Rs 1,155 crore
and 4.37% stake in Titan Industries. It also plans to sell
50% stake in Dharma Port in Odisha.
– Reliance Communication has raised Rs 4,800 crore by
selling fresh equity.
– GMR Infra has realised Rs 1,659 crore from sale of
40% stake in the Turkish Airport.
– Ashok Leyland has made close to Rs 400 crore by
selling stake in IndusInd and Defiance Testing and
Engineering Services Inc, USA
– Bharti Airtel has raised Rs 2,100 crore by selling a
4.5% stake in Bharti Infratel. It plans to sell 3,100
telecom towers in four African countries to Helios
Towers.
– Lanco Infratech has sold 1,200 megawatt Udupi
power plant in Karnataka to Adani Power for Rs 6,000
crore. Lanco will receive Rs 2,000 crore from the
transaction, while Adani will acquire Udupi Power’s Rs
4,000 crore debt.
WHY ASSET SALE MAY NOT ALWAYS WORK
– Proceeds from asset sale may be too small compared
to the total debt to have any meaningful impact on the
stock price.
– In some companies, debt can be due to stuck
projects. In such a scenario, asset/equity sale may not
have a significant impact on the stock performance.
– Some of the companies are selling cash-generating
assets, which may impact their cash flow, neutralising
the overall impact of the cut in debt.
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