The impact of rate hike is likely to trickle down to companies across the globe.The world has enjoyed nearly a decade of historically low-interest rates and loose monetary policy.
More so in the aftermath of the pandemic, as the Federal Reserve lowered interest rates and bought financial assets to stimulate growth and bolster markets.But now, as the Federal Reserve and the European Central Bank plan to raise interest rates, this could signal the end of the accommodative policies that markets have enjoyed so far.The impact of this action is also likely to trickle down to companies across the globe.
Especially those that are highly indebted.So, how do we define a highly indebted company?Highly indebted companies are not just companies with high debt levels on their books.
A high level of debt alone cannot define the company's ability to service it, which is an indelible feature of an indebted company.There is a good chance that companies with high debt can generate strong cash flows to service their interest cost and re-pay the debt comfortably.
So even if a company has a pile of debt, it doesn't necessarily mean it is in trouble.Therefore, a better way to identify the risk is to analyse their interest coverage ratio.The interest coverage ratio measures the ease with which a company can pay back the interest due on its total debt.
Taking the company's profitability and annual interest payments into consideration, this is an important ratio.Now that we know the right way to filter indebted companies that can be at risk, let's look at the five most indebted companies in India and see if higher interest rates can bring them down.#1 Macrotech DevelopersFounded in 1980 by Mangal Prabhat Lodha, Macrotech Developers is one of the leading real estate firms in the country.The company markets its properties under the famous 'Lodha' brand.
It enjoys a leadership position in its existing micro-markets with a 15-30% market share and aims to replicate the same in new markets.Macrotech Developers not only sports a large pile of debt but also lacks the ability to repay it via internal cash flows, as reflected in its low-interest coverage ratio.As the pandemic ravaged the economy, the companys sales dropped in half.
Combined with large interest payments, it wreaked havoc on profitability.But what followed was a boom in the real estate sector in India, propelling the company's quick recovery.
The company reported record sales, which helped it generate strong cash flows.Rosy as its performance was, it could retire only a tiny part of its debt.
And so, with a large debt on its books, and poor coverage ratios, Macrotech Developer decided to focus on debt reduction.The company recently raised about Rs 2,100 crore through a QIP and repaid a part of its debt.However, since 35% of its debt is due for re-payment next year, by mid-2023, the company cannot possibly generate adequate cash flows to cover those large payments.Any rise in interest rates will only increase its interest burden, dampening its profitability further.An interest rate hike is usually followed with a slowdown in demand.
Home-buyers, in the near term are likely to rethink buying decisions, affecting the company' sales.Beyond that, the company's single market focus and business cyclicality can affect its profitability over the long term, posing serious challenges ahead.Another big worry is the higher cost of borrowing.
Since a large part of its debt (90%) is from Indian financial institutions, it has a high rate of interest (about 11%).
This puts pressure on the company's ability to generate robust cash flows.However, they do have one trick up their sleeve.The promoter holding stands at 82%.
This level is way above the SEBI's minimum public shareholding norm of 75%, which gives them ample scope for debt reduction via a share sale.So, there is a good chance the company will raise more money via a stake sale.#2 Tata MotorsDespite being a leader in the domestic commercial vehicle segment with a well-established presence in the global luxury car market via Jaguar and Land Rover, this Tata group company is on the list of the highly indebted Indian companies.The automobile sector has not been doing well since 2018.
Due to policy changes and vehiclefinancing issues, most auto companies have been underperforming.When Covid turned into an economic crisis, auto companies were hit harder than most.
Dwindling demand in an already weak sector, left auto companies in bad shape.
Even now, rising raw material costs and semiconductor shortages have eaten into their profitability and sales.JLR has been losing its market share in the international market, which forms a large chunk (more than 75% of the total revenue) of its business since 2017.Despite being the market leader (47% share) in the Indian commercial vehicle segment, the company's performance has been weaker than its domestic and international counterparts.It has been losing market share in the EV (electric vehicle) segment in the international market.
As the sales of EVs rose significantly across the globe, JLR has been lagging.Its share in the EV segment is less than 1% in the US and China and around 2% in Europe.
What's worse is that it has no plans to launch any EVs before 2024.A worrying factor, this loss in market share can hamper the company's profitability as well as its ability to successfully repay debt.However, a rise in interest rate is not a big concern.
Unlike Macrotech, most of the company's debt is from foreign institutions with a far lower interest rate at around 5-7%.Moreover, the company has another 3-4 years to repay its debt.
Most of it is due for re-payment by 2025.
This gives it ample time to generate strong cash flows.#3 Bharti AirtelHeadquartered in India, Bharti Airtel is a global telecommunications company operating in 18 countries across South Asia and Africa.The company ranks among the top three mobile operators globally, with its mobile network servicing a population of over two billion people.But investors have been incessantly concerned over the astronomical debt sitting on its books.Even though the telecom sector offers a large upside due to the 5G roll-out, most telecom players have a weak balance sheet.With huge investments in spectrum acquisition and 5G deployment, telecom companies often raise money via borrowings or stake sales.
And Bharti Airtel is no exception.Ahead of the proposed 5G spectrum auction, the company raised over Rs 2,000 crore via a rights issue last year.It has also renewed its focus on deleveraging the balance sheet.
With the change in the competitive landscape and stronger growth prospects, the company is confident of its ability to repay debt.
There is also a good chance the company might meet its targets.Only 20% of the total debt due in the next 2-3 years.
A majority of its debt is due from 2026 onwards through to 2030.
Besides, the low-interest rate of around 3-8% on 70% of the debt is a big respite.Considering this, international rating agency S-P maintained Bharti Airtel's credit rating at 'BBB-' and upgraded the outlook from negative to stable.
This indicates confidence in the company's financial status and ability to pay back debt.Therefore.
the much-anticipated interest rate hike should not be a big concern for the company.#4 Adani Green EnergyOne of the largest renewable energy companies in India, Adani Green holds the largest solar power generation capacity globally.Generating power through renewable sources such as solar and wind energy, the company builds, develops and maintains utility-scale grid-connected solar and wind farm projects.But building such large-scale operations earned it not only a big name but also a place in India's top indebted companies list.The company's growth came on the back of tremendous borrowing.
It has added a lot of debt to fund its capex.This has ballooned up 5 times in the past 5 years from Rs 3,600 crorein 2017 to Rs 19,700 crore in 2021, which is a big cause for concern.To add insult to injury, 30% is due in the next year and another 30% by 2024.So even if the company replaces its debt, any spike in interest rates can exacerbate the situation.
Even now, a large part of the debt attracts a relatively high interest rate, a weighted average of about 9%.The company has failed to generate any positive cashflows, i.e.
the company's ability to repay debt from internal sources.
This is reflected in the low interest coverage ratio.So, if there is a spike in the interest rate it will have to replace the existing high rate of debt with an even higher rate of debt, putting a lot of pressure on the business to perform well in the near-term.#5 Tata PowerAs India prepares to leap forward in developing cleaner energy sources, Tata Power is equipping itself every step of the way.What started as Tata Hydroelectric Power Supply Company in 1911 is now India's largest integrated power player.
Be its power generation, transmission, or distribution, this well-known company is present across the entire energy value chain.Aiming to be the frontrunner in India's clean energy revolution, the company has been investing heavily in clean energy generation.
It's building an expansive EV infrastructure and setting up EV charging stations across the country.But all this expansion comes at a cost.
The company has borrowed heavily and is now one of the most indebted companies in the country.Moreover, the ability to re-pay debt via internal sources has been compromised, as reflected in the low interest coverage ratio.So can a hike in interest rates affect the business drastically?Add image caption hereThe company has undertaken effective steps to deleverage its balance sheet.
In the recent quarter, the company reduced its gross debt to the extent of Rs 3,000 crore despite a capex of Rs 1,600 crore.Also 60% of the company's total debt is long-term, due for re-payment only after 2024.
This gives their clean energy projects time to come on stream and generate robust cash flows.Despite borrowing from Indian institutions, the company's weighted average cost of debt (interest rate) is 7.5%, which is not alarming.
So, unless the business suffers dramatically, any rise in the interest rates does not pose a serious risk to the company.Other than an increase in the cost of debt, rising interest rates also pulls back demand in most industries, affecting profitability.
So it might get increasingly difficult for companies to generate more money to repay their loans due with a year.To concludeAs you can see from these examples, higher interest rates need not spell doom for companies.
In fact, in the case of some companies such as banks and NBFCs, a higher interest rate environment could propel growth.Moreover, debt can help companies grow and expand.
It's only when the debt is unserviceable that the company will find itself in trouble.So if you plan to invest in high debt stocks, be sure to do your homework.Assess the fundamentals and future growth prospects of the company in question.
A 360-degree overview of the business will help you make an informed decision.Disclaimer: This article is for information purposes only.
It is not a stock recommendation and should not be treated as such.(This article is syndicated from Equitymaster.com)(This story has not been edited by TheIndianSubcontinent staff and is auto-generated from a syndicated feed.)