Tatas and Birlas will have to downsize: too much debt

Two newspapers, two different stories. But it’s the same message when read between the lines. A few days ago The Economic Times put out a story indicating that one company - just one - accounted for 61.4 percent of the Tata group’s market valuation. No prizes for guessing that company’s name: Tata Consultancy Services (TCS).

Today’s Business Standard put out another story suggesting that companies with little or no debt (excluding banks and finance companies) accounted for nearly three-quarters of the BSE 200’s market capitalisation. The BSE-200 is practically a proxy for the entire market. The newspaper’s research shows that the 10 most indebted firms in the index accounted for only 1.3 percent of its market-cap (again excluding the financial sector). So, it concluded that the market isn’t as vulnerable as it looks.

That remains to be seen, but the reason why indebted companies have such a low weight in the BSE 200 is that they have already been at the forefront of wealth destruction over the last few years. When you destroy value, your share in the index automatically falls since all major indices are weighted by market value. The only companies that gained or maintained value are those that kept debt in check.

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This also connects with The Economic Times story which tells us why TCS accounts for 61.4 percent of the Tata Group’s market valuation. The rest of the group has been destroying value by overloading itself with debt, especially flagship companies such as Tata Steel and Tata Power.

[caption id=“attachment_1010157” align=“alignright” width=“380”]  The rest of the group has been destroying value by overloading itself with debt, especially flagship companies such as Tata Steel and Tata Power. Reuters[/caption]

Consider what’s going on. After Tata Steel bought Corus, it raised so much debt to finance the overvalued company that it is today reeling under it. A Mint report quotes a Bank of America Merrill Lynch research as saying that the company could end this financial year with a net debt of Rs 63,200 crore, and its cash flows are barely adequate to cover its interest costs.

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Contrast this with the company’s market valuation of Rs 19,400 crore (mid-morning on 5 August), and you know why debt is killing corporate India rather than just the slowdown. In fact, the slowdown is partly the consequence of companies raising too much debt when there was excess liquidity in the system upto 2008. They are now deleveraging - and making the slowdown worse.

Tata Steel pays three-fourths of its earnings before interest, depreciation, tax and amortisation (Ebidta) in interest. It is very close to falling into a debt trap.

The same story holds for Tata Power. It has debts of Rs 35,000 crore against a market value of Rs 19,600 crore.

So Tata Steel’s market value is a third of its debt, and Tata Power’s half of debt. The market clearly does not like companies that tanked up on too much debt.

Nor is this a mere Tata story. Even the cautious Birlas threw caution to the winds with their acquisition of Novelis in Canada some years back. The net result: Hindalco’s net debt as at the end of 2012-13 is up to Rs 45,721 crore, and it could rise higher as the company continues investing in new aluminium capacity back home.

The Hindalco stock is now at around Rs 96, down 37 percent from the start of the year. Debt has again destroyed value.

The only way the Tatas and Birlas can reduce debt is by selling off some of their assets to raise cash. This means both the Tatas and Birlas must downsize, not to speak of the rest of the over-indebted companies of India Inc.

The big challenge for corporate India is thus deleveraging - reducing debt to manageable levels. In fact, more than anything else, this factor is behind corporate India’s unwillingness to invest further. How can it invest when it has to pay back debts?

Take the case of Tata Power. For the next two years, the company plans to stop investments to bring down debt. A Financial Express report quotes S Padmanabhan, Executive Director, as saying: “The next major plant investment will not happen in the next two years or so, as most projects are in the land acquisition phase and the debt levels will start to come down….We are planning to sequence our investment to lower debt levels.”

A Business Standard report quotes Apollo Tyres’ Vice-Chairman & Managing Director Neeraj Kanwar as saying India won’t get any investments for now. He said: “There is a very clear growth-capex programme that has been identified. Plants with the opportunity to grow will be the first ones (to get investments). So, you would have Serbia, China and, later, Mexico. India right now does not need any growth capex… we will just be doing maintenance capex here.”

Apollo’s story is not unique. Entire companies, from DLF in real estate to infrastructure players such as GMR and GVK, have to bring down debt.

However, the real story of deleveraging is still to unfold. While the bourses may have slapped high debt players with lower valuations, the real damage will show up when banks start paying for their sins of excess patronage of debt-ridden groups. The sharp drop in the market valuations of banks shows that this is already underway. The BSE Bankex fell 20 percent this calendar year - led by public sector banks.

Since banks are essentially about leverage, the rise in bad loans means they too will have to conserve capital or recapitalise themselves. They cannot afford to lend to easily in this scenario. To corporate deleveraging, we have to add bank unwillingness to lend as another issue that will slow down growth.

Add the rupee’s own travails, and one can’t see interest rates coming down in a hurry. The government’s own borrowing requirements - whether to pay for ruinous subsidies or to bail out banks or electricity companies - will ensure that rates stay high.

The bottomline is this: despite the exertions of P Chidambaram to improve the investment climate, India Inc is focused on a different concern. Debt is going to ensure that the slowdown endures.