The uptrend in interest rates and slowdown fears could hurt profitability of companies with high-debt.

The uptrend in the domestic interest rates and fears of a slowdown in industrial activity is not good news for companies that continue to have high debt in their books. India’s central bank, the Reserve Bank of India (RBI), continues to have a hawkish view due to the high inflation rate. Since January this year, it has increased the repo rate by 50 basis points to 5.25 per cent and cash reserve ratio by 100 basis points to six per cent.

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“Generally, higher interest rates mean higher interest costs. But the impact would be greater in the case of companies with high leverage in their balance sheets, or where business fundamentals are weak. However, it is subjective and the impact could be different for different companies,” says Deven Choksey, managing director, KR Choksey Shares and Securities.

In the backdrop of this emerging scenario, companies with high debt burden (particularly those where business fundamentals are not improving in a meaningful manner) and an inadequate cover to service the increased interest cost may feel the pinch.

We crunched numbers to figure out companies with high debt (debt-to-equity ratio in excess of one), low interest cover, subdued return ratios and market value of over Rs 1,000 crores. The table mentioned below, however, is only indicative and suggests that these companies could be vulnerable in a rising interest rate scenario. Read on to know more:

The prominent ones
Alok Industries, has seen its interest cost go up by 78 per cent in the June quarter, thanks to its huge debt in the books.

While textile firms like Alok benefit from lower-cost debt from the Textile Upgradation Fund, its debt-to-equity – at 3.4 times – is not very comforting as the near-term industry outlook is not very promising.

While the company hopes to monetise its land bank and reduce debt, analysts believe it may not be able to make a significant profit from sale of land.
 

In the telecom space, Tata Teleservices Maharashtra is on a weaker wicket, considering its deteriorating financial performance. It has a huge debt of Rs 3,940 crore — a major reason for analysts to expect the company may continue to post losses over the next two years.

For Suzlon Energy, which continues to hold a large debt, the industry environment has not improved much. Though it has managed to lower its debt, the consolidated debt-to-equity ratio is still high and interest coverage ratio very low.

Experts suggest that, during any downturn in the industry, companies with higher debt levels get hurt the most. And, that’s especially true with cyclical sectors like sugar, metals, etc.

For Bajaj Hindusthan, analysts expect it to report a 52 per cent decline in its earnings before interest, taxes, depreciation and amortisation (Ebitda) at Rs 200 crore for the next year (sugar season 2010) due to lower sugar prices and high cost inventory. What is noticeable is that it will pay Rs 281 crore in interest costs next year, which means substantial net losses in that year.

Restructuring debt
The good part is that many companies are restructuring their debt and taking measures to minimise the burden, which is why investors need to be watchful. These include Jet Airways, Kingfisher, Bombay Dyeing, Aban Offshore and Alok. However, the net impact will depend on their debt restructuring and other related measures.

Airline major Jet has lowered its debt and improved profitability, which places it ahead of its rival Kingfisher. Of late, carriers have benefited due to a recovery in passenger traffic, improved utilisation, relatively higher realisations and lower fuel prices. But this has largely augured well for Jet, which is expected to report profits this year.

Also, the company is looking to monetise its land bank, issue equity worth $400 million along with sale and lease back of aircraft.

Kingfisher paid Rs 1,097 crore as interest in 2009-10 and reported an operating loss of Rs 899 crore. While it turned around at the operating level in the June quarter, considering its high debt, analysts expect the company to return to profits only after 2013. Positively, Kingfisher, too, is looking to restructure its debt and plans to raise Rs 5,000 crore through issue of equity shares which, if successful, should ease the burden.

Among other prominent cases of high-debt companies is Bombay Dyeing.

On the bright side, it holds about 64 acres in Worli and Wadala in Mumbai, which it intends to monetise to bring down debt over a period of time. Its success on this front will determine how fast it can deleverage its books.

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