Fresh debt defaults on horizon: Check out stocks on watch list
The problem is more pronounced in housing finance companies and shadow banks.
A sustained selloff in domestic equities for several months now has resulted in a situation where market capitalisations of many companies have slipped below their total outstanding debt.
This creates a serious challenge for domestic banks, as the biggest chunk of their corporate books is tied up to many of the financially-stressed firms.
Data available with Ace Equity showed as many as 190 BSE-listed companies had aggregate debt of Rs 18.89 lakh crore on their books against total market capitalisation of just Rs 5.54 lakh crore as of August 26, 2019. It means these companies owe over 3.4 times their total market valuation to banks in outstanding debt.
Several prominent names figure on the list, including NTPC, Vodafone Idea, Srei Infra, GIC Housing Finance and Power Finance, among others.
Steel manufacturer and exporter National Steel & Agro Industries has a debt-to-market cap ratio of 133, with a debt of Rs 1,165.60 crore and market value of mere Rs 8.8 crore. A similar story is playing out on counters like Tata Teleservices (Maharashtra), Adlabs Entertainment, McLeod Russel India, PNB Gilts, Steelco Gujarat and Hindusthan National Glass & Industries, which owe over 10 times their market valuation in outstanding debt.
“India Inc is guilty of over-leveraging,” says Amar Ambani, President, YES Securities. “After the US sub-prime crisis of 2007-08, the Indian corporate sector accumulated large debt on their books. Such companies can be risky bets, as debt and interest payment obligations are going to keep on mounting, leading them into debt traps,” Ambani said.
While the government has just released Rs 70,000 crore towards recapitalisation of public sector banks, trying to reinvigorate the credit cycle, the risk is that on the corporate side those in need of credit are mostly in a debt mess.
Steer clear of companies with high debt on their books, says Vinod Nair, Head of Research, Geojit Financial Services. “It shows two things; first, the stock has taken a toll relatively during the correction phase, and secondly, debt repayment is going to be tough in such rough patches,” he said.
Ambani of YES Securities pointed out that the imbalance between debt and m-cap may trigger a fresh wave of corporate defaults.
There is a serious issue of over-leveraging in the economy and it is increasingly becoming difficult for companies to improve balance sheets in the current depressed scenario of the market and the broader economy.
The problem is more pronounced in housing finance companies (HFCs) and shadow banks (NBFCs), but not limited to them.
Other firms belong to capital-intensive sectors like textile, telecom, auto and auto ancillary, cement, mining real estate, power, infrastructure and engineering.
LIC Housing Finance, Tata Steel BSL, PNB Housing Finance, Future Enterprises, Indiabulls Housing Finance, Avadh Sugar & Energy, Indostar Capital Finance, Steel Authority Of India, Shriram Transport Finance, Can Fin Homes, Emami Paper, Suzlon Energy, Bombay Dyeing, Jindal Stainless, M&M Financial Services and JK Tyre & Industries all have debt exceeding their market cap.
Low valuations and the vicious cycle of low liquidity-poor profitability-earnings downgrade, if any, may further accentuate the problem.
“If debt is about 1.5 times or higher than market cap for a long term, it is not considered a good omen. But in capital-intensive sectors, this level can go a little over 1.5 times,” said Nair.
He said one can ignore NBFCs and housing finance companies (HFC) from this equation, as debt works as capital for these companies.
There is a need companies to try internal management to seek ways for cash flow and fund operations if the economic turnaround takes longer than expected.
Companies should try and seek a balance between access to capital and excess of capital to avoid this vicious circle, which can lead to inadequate market capitalisation in a bad phase of the market.
Not surprisingly, some of these companies are under constant scrutiny by analysts, leading to further downgrades. Recently, global rating agency Moody’s downgraded Indiabulls Housing Finance’s long-term corporate family rating to Ba2 from Ba1, while changing its outlook to negative from stable.
The international rating agency said the downgrade reflects renewed pressure on cost and availability of funds for Indiabulls Housing Finance (IBH) and certain other finance companies.
“At the same time, companies focused on cash flow and better productivity can becomes multibaggers over times,” says Ambani.
“It is possible that some companies have humungous debt and compact market caps, but if the business picks up and the company is able to generate cash flow, it can ultimately help reduce debt. In such a scenario, the relative market-cap would ultimately rise helping the stock to deliver multibagger returns,” said Ambani.
Geojit’s Nair said every company has its own plan to take, manage and repay debt. Troubled companies usually sell core and/or non-core assets to meet debt obligations. “If one finds buyers at fair price, that can work as a remedy.”
But should investors catch falling knives?
Barring Manappuram Finance, Cholamandalam Investment, Power Grid, Ind Bank Housing and Sonal Mercantile, other companies on the list have not given positive returns to investors since January 1, 2018.
On the other hand, companies like National Steel, Adlabs Entertainment, McLeod Russel, Quadrant Televentures, WS Industries, Vodafone Idea and Premier have tanked up to 90 per cent in the same period.
“Look at management guidance and their commentaries before taking an investment call. If the management sounds confident enough to make a turnaround, then one can look at quality stocks with strong fundamentals,” said Nair.
Spotting a stock among such companies is a high-risk, high-reward proposition. Leveraging can work bot. Therefore, one should be very careful in investing.
“One should not try to catch falling stocks without proper analysis, as these are knives which have already fallen and hit the floor. Investors need to study company specifics, look at outstanding debt levels and study its ability to generate cash flow to repay debt based on the business model,” Ambani said, adding that one should refrain from sectors like telecom, as debt management would be tedious job over there due to cut-throat competition.