Krishnamurthy Vijayan/Chief Executive Officer/JM Mutual
this quick quiz: Over the past few years, India Inc has been able
to make huge savings in interest costs because:
A: Interest rates have been coming down
B: Companies have been restructuring
their high-cost debt
If you've chosen A-which appears the most obvious
answer-you, of course, wouldn't be wrong. But you'd be equally on
the button if you attributed corporate India's savings to the financial
restructuring a host of chief financial officers have been taking
recourse to. Along with excess employees, company managements have
been pulling out all stops to get rid of their high-cost debt. While
some of them are replacing it with lower-cost loans, in the process
bringing down their interest burdens, others have gone one drastic
step further and paid off their debt all together. Example: Textiles
major Raymond. "We have prepaid the debt wherever possible.
Most of our high-cost debts have already been repaid and only areas
like old retail fixed deposits (that can't be prepaid) are still
remaining," says R.A. Prabhu Desai, Executive Director (Finance),
The steady increase in the number of companies
going in for debt reduction year after year is reflected in the
industry aggregates as well. As the chart (See Forsaking Debt) indicates,
the debt/equity ratio of India Inc has been coming down over the
years. This is based on a sample of 400 companies (only non-finance
companies) whose audited figures are available for all these years.
During these years, most of the zero-debt companies in the sample
have maintained status quo. The best example for this is Infosys.
Meantime, those companies with small debt components have shrunk
them further. For example, Hindustan Lever has reduced its debt/equity
ratio from 0.15 per cent in December 1998 to 0.02 in December 2002.
A deeper look at our sample reveals that there is not much of a
change amongst the traditionally less leveraged sectors (like software
services and fast-moving consumer goods). The real action has taken
place among the mid-cap companies from the manufacturing sectors.
The table (See Fat-Free Diet) lists out 10 companies whose debt
has come down by the most.
Now for the question: Why is corporate India
on a massive debt reduction exercise when interest rates are at
very low levels? To be sure, aversion to debt has become quite a
fad with India Inc. Bump into any CFO, and chances are he'll either
wax eloquent about how he made his company a zero-debt firm, or
how he is working towards that goal. "We do not take on debt
unless it is required, irrespective of interest rate levels,"
says Bruce Inglis, CFO, Philips India. Worldwide Philips operates
with no more than 30 per cent debt. Inglis says that in India Philips
will attempt to keep the debt portion within the 0-20 per cent range.
Dalal Street Likes Zero
The reason for that zeal is pretty evident:
Most of the fancied companies on the stockmarkets are zero-debt
ones. That obsession of Dalal Street for zero, or near-zero-debt
stocks, is explained by the fact that such companies are better
equipped to withstand economic downturns. So, although highly-leveraged
companies are better placed to chase higher growth, they have a
higher element of risk attached to those ambitions. Stockmarket
investors for their part demand a premium for this higher risk in
the form of lesser price. It's not just Dalal Street, but even the
lenders that prefer a zero-debt company, and they express their
penchant for such firms by offering lower interest loans. "We
have decided to become debt-free company now with a clear objective
in mind. When we identify a strong project and approach the market
with it, we should get very good credit rating and should be able
to raise funds at best possible coupon rates," says Amit Ghosh,
General Manager (Finance), Tata Metaliks.
Also, the focus of India Inc has moved from
creating assets to increasing shareholder value. In other words,
companies now have started looking at profitability and not just
size. "They are now concentrating more on profit growth quarter
on quarter and year on year," explains N. Jyothimani, Fund
Manager at CanBank Mutual Fund. So the focus is now only on new
projects that can generate positive returns. "The interest
cost is only one part of deciding on new projects, the other (and
more important) part is the business environment," adds M.R.
Rajaram, CFO, ICI India. Clearly India Inc has realised there is
no meaning in generating debt and squandering it just because it
is cheap. "The way we look at debt is like the industry treats
the bridge loan. Either short or long, at the end of the day it
has to be repaid," points out Ghosh, of Tata Metaliks
Indian managements are also learning to allocate
their capital more efficiently. After the initial euphoria of liberalisation,
when capacity expansions across disparate industries took on mindless
proportions, India Inc today is more focussed and sticking to what
it knows best. This is done by way of getting rid of businesses
that are outside their core area. For example, a company like Raymond
has generated surplus cash by selling its cement and steel businesses.
Idle assets like real estate are also being hawked. ICI India has
generated more than Rs 150 crore by selling its properties. The
money generated from these sales are used not just to prepay debt
but is also ploughed back into the core businesses. Kalyani Steels
has managed to put up a co-generation plant with a capacity of 7.5-8
mw at a cost of around Rs 27 crore even after reducing its debt
by Rs 146 crore during the last four years. "Once it is completed
in 2004, we will be getting electricity with out any fuel cost,"
said C.G. Patankar, Executive Director, Kalyani Steels.
Working Capital Efficiency
Doubtless one of the most important reasons
for the aversion to debt is the tremendous improvement in working
capital efficiency. Companies have adopted technology (by installing
packages like ERP, sap, etc) to streamline their operations. This
has helped reduce the turnaround time of inventory (of both raw
material and finished goods). Credit periods too have come down.
"The best example of this is the automobile industry where
inventory carrying costs used to be very high earlier," points
out Krishnamurthy Vijayan, CEO, JM Mutual Fund. Since the debt component
includes working capital, a lower working capital requirement naturally
means lower debt. "And this is a very healthy signal,"
says Mr Tridib Pathak, Fund Manager (Equity), Principal Mutual Fund.
The consolidation of manufacturing capacities
too has played its part in debt losing its attractiveness. As JM
Mutual's Vijayan explains, during the manufacturing boom four-to-five
years ago, plenty of capacities were created. "This resulted
in low margins for companies. Today, though, many of them can manage
with the existing capacities, without having to create new ones,"
he adds. "Our production can be increased from 2.9 lakh tonnes
to 4 lakh tonnes without installing any additional capacity. So
we are using the cash flows to repay high cost debt," confirms
Patankar of Kalyani Steels.
However, as the demand-supply imbalance eventually
disappears, the next wave of capacity creation is inevitable. And
that could once again enable debt to regain its lustre. However,
the frenzied asset-creation one witnessed post-liberalisation is
unlikely to repeated this time round.
"Industry has become more mature now,"
avers M.K. Srinivasan, Senior Vice President (Finance), Paper Products.
What's more, rather than just looking at the domestic demand, promoters
have got to factor in the global outlook. "Unlike the past
when companies used to look only at the Indian situation before
setting up capacity, any new capacity addition has to be globally
competitive now," agrees ICI India's Rajaram.
Clearly, the advantages India Inc stands to
gain from debt reduction and improving internal efficiencies will
ensure that they continue to follow on the same path. "Profitability
has increased because of falling cost of funds and improved efficiency.
Companies are using these cash flows to reduce debt and improve
the efficiency, which will improve profitability further,"
explains Ved Prakash Chaturvedi, CEO, Tata Mutual Fund. Amen.