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Lessons in Debt for Equity Analysts
Most equity analysts I have interacted with till date had little understanding of debt beyond leverage ratios. As a result, they are not able to fully comprehend the risks associated with debt. Here are a few lessons for equity analysts. 1/11
Most equity analysts I have interacted with till date had little understanding of debt beyond leverage ratios. As a result, they are not able to fully comprehend the risks associated with debt. Here are a few lessons for equity analysts. 1/11
1. Unviable promoter level debt would adversely impact the operating company eventually. A promoter who is financially cornered will always look for ways to squeeze money out from the operating company. Some of these desprate measures could well be unscrupulous. 2/11
2. A debt-stressed company drains out healthier companies of the group. It is rare that a promoter lets go of a company easily. He tries hard to support the weaker entity through the resources of stronger entities (via ICDs, guarantees etc.) thereby jeopardising the later. 3/11
3. Many companies have a tendency of hiding debt support to group entities. A corporate guarantee shows up under contingent liabilities. DSRA guarantee appears only partially. Letters of comfort/ undertakings evade balance sheets. Quiz managements about these supports. 4/11
4. Low cost of funds doesn't always mean great treasury management. Check if company is funding long term liabilities by cheaper short term debt. Low cost of funds could also be on account of un-hedged foreign debt. Hedging is a cost but it prevents large, unexpected losses. 5/11
5. Borrowing through capital markets is cheaper but is not a stable source of funding. Capital market lenders vanish at the first sign of trouble (by exercising options or citing covenant breaches).Banks are relatively more reliable. A mix of both is the optimum solution. 6/11
6. Keep an eye on the rate of borrowing. If a company is borrowing at a rate higher than comparable peers or same rating companies, it's a sign of trouble. Debt analyst are good at identifying credit chinks and usually add a few basis points for taking additional risk. 7/11
7. Convertible debt instruments subscribed by promoter usually don't convert. These instruments are used by promoters to artificially bump up equity capital. These are either redeemed or are used to take valuation benefits once another equity investor decides to invest. 8/11
8. Many companies hide their lending (to group companies) or borrowings by settling the debt one day prior to quarter end. This debt is reissued and subscribe by the same counter-party a day after the quarter end. Debt, that way, by-passes the balance sheets. 9/11
9. Management has a separate pitch for different sets of analysts. In equity calls, the managements often focus on growth and RoEs. The same management, in debt meetings, moderate their growth plans so as not to indicate accumulation of debt. 10/11
10. Hybrid debt is not always bad. A high proportion of subordinated and perpetual debt in a bank/ NBFC book is an indication of (a) smart use of resources and (b) good acceptability from investors given that these instruments are long tenured and unsecured in nature. 11/11
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@contrarianEPS @shyamsek @chokhani_manish @pvsubramanyam @BalakrishnanR @Sanjay__Bakshi
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