Basically, businesses have two primary avenues for acquiring capital to support their growth: equity and debt. Companies with a substantial amount of debt on their balance sheets often appear worrisome, while companies with minimal debt are generally seen as appealing. Despite debt being regarded as a more cost-effective funding option than equity, thanks to its tax benefits, equity necessitates sharing ownership with investors.
In general, there are two main categories of borrowing: long-term and short-term. Long-term borrowing is typically used for capital expenditures (Capex) aimed at expansion and it is beneficial if a company can effectively manage and repay it. To cover the interest expenses associated with the debt, a company must increase its top line, which refers to its revenue and eventually its operating profit. The interest coverage ratio is crucial for companies that have leverage on their balance sheets. This ratio measures the ability of a company to easily meet its interest obligations. It is advisable for investors to steer clear of companies that rely on debt to manage their working capital, which pertains to day-to-day operations.
Following are the companies which have effectively reduced the debt levels on the balance sheet:
KRBL Ltd, Lloyds Metals ltd, Fine Organic Industries ltd, Suven Pharmaceuticals ltd, Rolex Rings ltd, Rites Ltd, Elecon Engineering Company ltd, Transport Corporation of India ltd, Krishna Institute of Medical Science Ltd, Data Pattern ltd, Jyothy labs ltd, Aether Industries ltd, Hindustan Copper ltd, Gujarat State Fertilizers & Chemical ltd, Zyduss Wellness ltd, Natco Pharma ltd, Gujarat Narmada Valley Fertilizers & Chemicals Ltd., GHCL Ltd, Surya Roshni Ltd, Titagarh Wagons Ltd.
The aforementioned companies were chosen based on two criteria, debt to equity ratio of less than 1 and seen a debt reduction over the course of three years.
Hindustan Copper Ltd has achieved a remarkable reduction in debt, slashing it by nearly 90% from Rs 1564 crore to 167 crore over the course of the last three years. The company’s Debt to Equity ratio now stands at an impressive 0.08 times, indicating a conservative debt level. Furthermore, with an Interest Coverage ratio of 25.8 times, Hindustan Copper Ltd demonstrates its ability to comfortably meet its interest obligations.
Gujarat State Fertilizers and Chemical Ltd has effectively decreased its debt from Rs 1559 crore to a mere Rs 2 crore in the FY2023. The company has achieved an exceptionally low Debt to Equity ratio is almost negligible, indicating an insignificant debt burden. Additionally, with an Interest Coverage ratio of 106 times, Gujarat State Fertilizers and Chemical Ltd showcases its ability to comfortably cover its interest expenses.
Overall, reducing debt on the balance sheet can improve the company’s financial health, stability, flexibility and attractiveness to stakeholders, leading to better growth prospects and long-term success. Indeed, it is accurate that reducing debt enhances a company’s attractiveness in terms of valuation. However, this factor alone should not be the sole criterion for selecting good investment opportunities. Investors should also consider other parameters such as Return on Equity (ROE), Return on Capital Employed (ROCE), Price-to-Earnings (P/E) ratio, revenue growth, profit after tax (PAT) growth and various other indicators. Evaluating multiple factors in combination provides a more comprehensive understanding of a company’s financial health and prospects for investment.