The two main factors that will hit India Inc's profitability hard over the next few quarters are one, the spike in interest rates, and two, the rise in input costs.
Top 10 companies in India with lowest debt to equity ratio; Should you invest?
With interest rate uncertainty projected to persist for some time, will it make more sense for investors to stick to zero- or low-debt stocks?
Impact of Interest rates
Analysts predict that a rate hike and a rise in bond yields will hurt India Inc's margins in the future. With corporate earnings already under pressure because of soaring input costs, the end of the era of cheap money is set to add to their challenges.
For the first time in nearly three and a half years, 10-year bond yields jumped to 7.5 per cent on Monday. The bond yield hit the 7.5 per cent level last seen on January 11, 2019, up 5 basis points from its previous close of 7.457-and prices moved in opposite directions.
The RBI will announce its policy on June 8th. Analysts expect a 50 basis points (bps) hike in the repo rate to 4.9 per cent this week and 25 bps in August to reach the first milestone of the pre-pandemic level of 5.15 per cent. Further CRR increases are on the cards to lower the liquidity surplus and aid transmission, according to reports.
Usually, when interest rates rise, the cost of borrowing capital for the company rises dramatically. This means that debt payment becomes increasingly expensive, slicing into a company's profit.
Furthermore, rising interest rates make it more expensive for businesses to raise money since they must pay high coupon rates on existing bonds. High-interest payments may also hurt their near-term earnings, which may impact their stock prices.
As interest rates rise, firm valuations may fall, and stocks are expected to become less appealing to investors as a result.
Moreover, high-interest payments will raise the cost of debt, and equity shareholders will expect a higher return because the majority of the firm's revenue will be diverted to debt payments, and less cash will be retained in the company. As a result, the WACC of the company will rise.
On the other hand, companies with low or zero debt are in much better shape in such a scenario, as the cash outflow through interest payments is not so much. These firms are able to keep their costs to a minimum.
|Company||Industry||Market Capitalization ( ₹in Cr)||Total Debt - Total Equity Annual|
|Maruti Suzuki||Cars & Utility Vehicles||233,776.8||0.0|
|Eicher Motors||2/3 Wheelers||72,681.2||0.0|
|Hero MotoCorp||2/3 Wheelers||51,108.6||0.0|
|Tata Consumer Products||Packaged Foods||70,351.3||0.0|
|HDFC Life Insurance||Life Insurance||281,976.9||0.1|
|Tech Mahindra||IT Consulting & Software||110,536.6||0.1|
Companies with low debt will have little exposure to interest rate risk as they are insulated from any rise in borrowing costs.
These companies have more control over their finances and can make quick decisions.
Further, debt-free companies are low-risk investments and, hence, are preferred by investors. These companies tend to have higher dividend yields and better returns on equity.
However, by not having an optimal or adequate amount of debt, these companies lose out to a greater extent on the ‘tax shield’.
Nature of Industry
Investors must understand that each industry has a different structure in terms of cash flow and funding requirements, among other things. As such, certain companies will always have a higher level of debt on their books.
For instance, all capital-intensive sectors generally see some selling pressure when interest rates move in a northward direction. These sectors include the manufacturing and industrial sector, the real estate sector, etc.
For capital-intensive industries such as iron and steel, cement, etc., not taking debt is extremely difficult. Generally, these industries have fixed and tangible assets, so it is easier for them to raise debt.
On the other hand, IT and FMCG firms have low debt because of their low requirement for capital. However, IT companies are exposed to exchange rate risk. So, the nature of the industry and associated risk play a major role.
Disclaimer: This article is for information purposes only. Please speak to a SEBI-registered investment advisor before making any investment related decision.