Check out stocks of these 10 companies that have cut debt
Investors should look at the extent of promoter pledging while buying such stocks.
Experts are also worried the debt crisis would spread to other sectors like automobiles where demand has been hit due to lack of easy financing. In such a scenario, investors would be better off sticking to companies with low debt.
Earlier, several companies with high debt had access to short-term loans from banks to tide over liquidity issues. Now, heightened risk aversion has made banks extra cautious while scrutinising the balance sheets of companies. With facilities drying up, defaults are on the rise. For instance, DHFL was recently forced to postpone repayments by a week, resulting in a rating downgrade.
Experts point out that the US Federal Reserve had taken several steps during the Lehman implosion to mitigate the crisis and are demanding similar actions here. “Lack of targeted measures by the government or RBI is compounding the debt market problem. If they don’t take timely actions, the crisis situation will become bigger,” says Ajay Bodke, CEO (PMS), Prabhudas Lilladher.
With the number of defaulting companies increasing on a daily basis, debt is the latest four letter word for equity investors. As a consequence, they have started shifting from high debt companies to low debt ones. “You will notice that companies with a debt-equity ratio of less than 1 have significantly outperformed companies with a debt-equity ratio more than 1, during the 3-5 year time frame,” says Rajesh Cheruvu, Chief Investment Officer, Validus Wealth Management.
Companies that are reducing debt are still affordable
Though shares of high debt companies are going at throwaway prices, shares of most debt-free companies are at a premium.
Compiled by ETIG Database. Only companies from BSE 500 considered; Companies with pledge ratio above 10% avoided
What should you do now?
First, investors need to understand that the ongoing credit crisis will continue for some more time and therefore, all investment actions should be based on this reality. Real estate continues to be the biggest trouble area. “The credit situation for developers is unlikely to improve in the immediate term. Developers are still hoarding their inventory with borrowed funds and continue to keep prices elevated for the unsold inventory,” says Cheruvu.
Though shares of most high debt companies are going at throw away prices, experts still don’t think investors should get in there. “Avoid high debt companies, they are like a falling knife now,” says Bodke. Cheruvu concurs with this view. “The focus of the market has been on ‘quality’ and this will continue for some more time. So stick with debt-free companies or companies that have brought down debt,” he says.
While the companies that are reducing debt is fine, shares of most debt-free companies are already at a premium. “Companies reducing debt is the most interesting space. It is better investors avoid companies with high debt and high promoter pledge in the current market situation. The opportunity is also less in companies that have no debt or no pledge because they are already at premium valuation. Opportunities are available only among companies in the middle,” says Jaspreet Singh Arora, Director and Head of Research, Systematix Shares and Stocks. Some rerating is possible once the debt reduction becomes visible to the market.
Steps to follow
While selecting companies that are reducing debt, investors should take some precautions. “First, a company’s debt should not be very high. Second, the quantum of debt reduction should be significant,” says Arora of Systematix Shares and Stocks.
For example, if the debt is high— debt-equity ratio is around 4—even a reduction to 3 may not be enough. However, similar debt reduction, when the existing debt is at 1.5% (DE ratio falls to 0.5) can be considered as significant.
Some of the debt-free and cash rich companies got into trouble in the recent past after promoters used the pledging route to divert money to infrastructure or real estate projects. So those who want to bet on companies with less debt should not ignore promoter pledge.
“In addition to net debt, investors should also consider the promoter pledge, because several financially sound companies are now crashing because of promoter pledge,” says Arora. While compiling our list, we have avoided stocks with more than 10% promoter pledge during the screening.