Leveraged expansions

In the past few years, companies have looked at debt reduction as an important way of improving profitability. With the economy now on an upswing, many core sector companies have started investing in capital projects.

A closer look at the financing pattern suggests that companies in the cement, automobile and oil and gas sectors prefer to borrow rather than invest own funds in new projects.

In 2002, BPCL, Indian Oil Corporation, HPCL, Grasim, ACC, Gujarat Ambuja, Hindalco, Indal and Nalco accessed the market for fresh borrowings to fund expansions.

Mahindra and Mahindra's Scorpio project was also funded through debt.

When one looks at the debt-to-shareholder-funds ratio, it is obvious that fresh investments are funded through debt rather than own funds. The companies mentioned above have shown a slight increase in the debt-equity ratio over the last two years, especially the long-term debt-equity ratio.

For instance, despite a two-fold increase in debt in 2002, Nalco's debt-equity ratio rose marginally from 0.22 to 0.35. Taking advantage of the low leverage in their balance-sheets, and the availability of funds at reasonable rates, companies borrowed money to reduce their cost of capital.

Replacement of high-cost debt

It is evident that most companies rejigged their debt portfolios by retiring high-cost debt and replacing it with low-cost debt. For instance, Grasim Industries, Gujarat Ambuja, Hindalco and Nalco, to name a few, have raised NCDs at lower rates in the last two years and repaid high-cost term loans.

Most of these companies were able to raise debentures at competitive rates to fund capital investments and, therefore, the total cost of debt worked out much cheaper than in earlier years.

For instance, the overall cost of debt for Mahindra and Mahindra dropped almost six percentage points over a three-year time-frame, and was just 8.4 per cent in 2002.

Fixed deposits lose sheen

Manufacturing companies appear to be shifting from fixed deposits to other means of raising finance. Around 80 per cent of the companies in the sample shrank their fixed deposit base. For instance, FDs, as a percentage of total debt, dipped drastically for such companies as Bharat Electronics, BPL, Exide Industries, Grasim Industries, Indian Hotels, SAIL, Ashok Leyland and Tata Engineering.

Accepting fixed deposits and servicing them becomes a cumbersome process for manufacturing companies. It might be easier to secure and service a lump-sum amount from one institution or bank rather than service a number of retail investors. This could have prompted companies to opt for other borrowing avenues.

Though Bharat Petroleum, Hindustan Petroleum and Mahindra and Mahindra increased borrowings through the fixed deposit route over the past three years, there was a sharp drop in the percentage of fixed deposits to total borrowings, even in these companies.

Efficiency improves

Dwindling interest rates have benefited corporate bottomlines across sectors, with the ratio of such costs to sales having declining. The phenomenon has particularly helped heavily leveraged companies such as Titan Industries and SAIL, which curtailed their interest costs in relation to sales.

For instance, interest as a percentage of sales slid from 8.7 per cent in 2000 to 7.2 per cent in 2002 for Titan Industries. Balrampur Chini reduced interest costs from 7.6 per cent to 3.2 per cent over a three-year period. On the other hand, BPL, Britannia Industries, Indian Hotels and India Cements, which are still facing sluggish demand, are shelling out a higher percentage of revenues as interest.

Debt ratings play a role

Companies with a lower rating have not benefited much by the falling interest rates. For instance, for Chambal Fertilisers, United Phosphorus and BPL, interest costs in relation to total debt were still high. United Phosphorus has a BB rating from Crisil for its long-term debt.

This rating indicates that the company is less vulnerable in the near term but, in the long run, might find it difficult to meet its financial commitments due to exposure to adverse business, financial or economic conditions. United Phosphorus has a higher proportion of short-term debt than long-term debt.

Over a period of three years, the company has repaid debentures in a phased manner and raised funds for the short term through bill-discounting, cash credit and term loans from banks. The rolling over of short-term debt and difficulty in raising funds through debentures or commercial paper at competitive rates due to a lower rating could have resulted in the high cost of debt.

Similarly, interest costs for Chambal Fertilisers have not shrunk in relation to its total borrowings. It has replaced its long-term debentures by term loans from banks and fixed deposits. While it has an A rating for long-term funds, its fixed deposits carry a double-A rating (an `AA' rating indicates a higher degree of safety than an `A' rating).

Restricted by heavy leverage

Companies such as SAIL, Tata Steel, Larsen and Toubro and Tata Engineering have been able to reduce debt over time and have shored up profits. But these companies have not really been as successful as in reducing the overall cost of debt.

For instance, SAIL has reduced borrowings by almost 8 per cent since 2000. Despite the debt reduction, however, the cost of borrowed funds remained almost the same, at 11.3 per cent. This is explained when one looks at debt in relation to shareholder funds.

Despite an 8 per cent fall, SAIL's debt in relation to shareholder funds was high, at 3.82 per cent. Relatively higher leveraged companies increase the risk from a borrower's perspective Therefore, procurement of funds at competitive rates may be difficult.

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