India experiences both high inflation and high interest rates. Immediate effect of both, on companies finance is negative.
High interest rates clearly affect companies operating costs & profit margins.
Companies which remain isolated from effects of high interest rates are debt free companies.
The companies which are more dependent on debt to manage their working capital, face the burnt of high interest rates.
Interest rates of debt is fluctuating. When interest rates goes up, it will eventually increase the expense of company. This will automatically translate into lower profits.
Zero debt companies in India are ones which are more self reliant. Such companies are best suited for long term investing.
Profitability of zero debt companies are generally more than high debt companies. Debt is a liability which has also a big cost attached to it. Debt gives immediate relief, but its also an expense for the future.
Hence companies which may be earning lesser profits, but carry zero debt, are more preferable by value investors.
In India we have several zero debt companies.
It will not be wrong for us to start identifying good companies using zero debt (or low debt) as one of our first screening criteria.
High interest rates negatively effects the profitability of high debt companies. In periods of soaring interest rates, low debt and debt free companies emerge as clear winners.
In India, interest rates remain very unpredictable. One never know when rising trend will start again. This mainly happens due to wavering inflation.
In India inflation can stabilize for few year. But even with minor changes on political front, inflation cuts deep again.
For investors it is important to keep a note of debt free companies in India. Keeping track of price valuation of zero debt (or low debt) companies is a very good idea. Timing purchase of such stocks is recommended.
I personally like companies carrying zero or very low debt.
Study of debt levels of companies certainly helps. How dependent is company on debt over long periods of time, speaks a lot about its fundamentals.
Only single year study will not be enough. Hence it is advisable to keep last 5 years financial reports of companies handy.
In this age of fast internet we can keep soft copies of financial statements. Internet enables access to information related to companies with click of a button.
Notes on Debt Free Companies:
1) Debt free companies are profitable stocks.
2) High interest rates reduces profitability of debt companies.
3) Zero debt companies have strong business fundamentals.
4) Debt free companies stocks must be preferred for investing.
5) Keeping ready-list of debt free companies is a good idea.
Interest Expense & Net Profit
Even small increase in interest rates can create a big hole in companies profits.
A company, whose turnover is Rs.34,000 crore, and incurs Rs.1,300 crore of interest expense. It means, its interest expense is 3.8% of the total turnover of company.
Generally speaking, 3.8% expense load on any one item, can be considerd very high.
Even marginal increase in interest expense can effect profitability. To negate high interest costs, companies must avoid maintaining high debt levels
In case debt levels cannot be reduced, companies profits reduces. This is one compromise high debt companies makes all the time.
Debt free companies are completely free of such compromises.
Companies which are debt free generates their liquid cash comparatively easily. This cash is used to manage current liabilities.
When there is no debt (immediate interest expense), companies liquidity level remains good. This makes day-to-day cash flow management relatively simpler.
Debt Free Companies are Ideal
Debt free companies are low risk companies for investors. Not only investors but even bankers love such companies. When need comes and such companies need debt, banks can lend them debt at low interest rates.
For investors, debt free companies are investment heavens. Debt free companies are like ‘financially independent’ business.
Such companies have enough cash generating source of their own. They do not need market debt to run their business.
This situation may sound simple, but it take decades for companies to reach this stage. But more than time factor (age of company), zero or low debt levels speaks volumes about how good is the companies management.
Running a big business, without being dependent on debt is worth a thousand praises. It is not an easy milestone to achieve.
This level of self-reliance can be achieved only due to perseverant management.
It has also been observed that, generally debt free companies share higher dividends with its shareholders.
If company is focusing on long term growth, they may not distribute high dividends. But big, debt free companies share reasonably high dividends and also manage fast growth.
Zero Debt & Business Fundamentals
In order to understand this correlation, lets take an example. Look into NMDC’s balance sheet. In last 10 years NMDC had zero debt. During the same period, company was able to increase its reserves at staggering rate of 28% per annum.
Zero debt and fast increasing reserves is an excellent indicator of strong business fundamentals.
NMDC’s is good example of debt free company. Looking at companies Profit & loss accounts, NMDC’s ‘Total Income’ has increased at rate of 19% per annum. While NMDC’s ‘Total expense’ has increased at rate of only 15% per annum. This differential between income and expense enhances companies profit and profitability. NMDC’s profit and profitability both has improved in last 10 years.
All debt free companies are Good?
Generally debt free companies are good bet for investment. But all debt free companies may not be good.
A scrutiny of business fundamentals is a must before one goes ahead and buy their stocks.
It will be good idea to check companies ‘Total Income growth (sales turnover)’. Though company is maintaining zero debt but; if it is not able to increase turnover, it will not be considered good.
To get more idea, compare sales turnover of company with its nearest competitors.
Concept says, it’s a good practice to keep debt levels as low as possible. But this should not be done at cost of ‘business growth’.
Companies which are compromising its growth are either complacent or does not have skillful & dynamic top managers.
A combination of high sales growth and low debt is ideal. Investors must keep track of such companies. Also, companies maintaining high profit margins automatically becomes most preferred by investors.
Debt Free Companies in India 2018
This time I am introducing a new concept of “Enterprise Value” to identify debt free companies.
To understand this lets take a small hypothetical example.
Suppose there are two companies ABC & XYZ. ABC has a debt of Rs.80 Crore and B has a debt of Rs.120 Crore. Which company looks better here? If we have to look only at debt levels, Company ABC looks less risky.
Now suppose, Networth of ABC is Rs.80 Crore and Net worth of XYZ is Rs.120 Crore. Means, the debt equity ratio (D/E) of ABC is 1 (80/80) and that of XYZ is also 1 (120/120).
So which company is better? Debt/Equity ratio being a very reliable debt burden indicator is not able to differentiate between ABC & XYZ. What to do?
There is a way out.
Suppose Company ABC and XYZ has a cash/cash equivalent reserves of Rs.75 Crore and Rs.132 Crore respectively.
Debt -(minus) Cash for Company ABC is = Rs.5 Crore (80-75).
Debt –(minus) Cash for Company XYZ is = Rs.-12 Crore (120-132).
A negative value for Company XYZ indicates that company is having enough cash to pay-off all its debt.
Hence, even if companies like XYZ is carrying high debt (Rs.120 Crore), it still as good as zero debt. This is because XYZ also has enough cash reserves (Rs.132 Crore) to negate its debt burden.
Such companies (like XYZ), whose Debt minus Cash value is negative, can be included in our list of debt free companies.
In stock metric terms, we will use the Enterprise Value and Market Cap to understand how big is the cash reserves of a company compared to its debt.
Enterprise Value minus Market Capitalisation = Debt – Cash
Example: In the below list of companies, you will note that companies like Page Industries, Dabur India & Natco Pharma has a debt/equity ratio of 0.13, 0.19 & 0.14 respectively. They have still been included in the list. This is because of negative “Debt minus Cash” component.
[Note: If you want to know more about Enterprise value, check this link….]
(Updated on April’2018)
- Infosys Ltd.
- Titan Company Ltd.
- Bosch Ltd.
- ICICI Prudential Life..
- Siemens Ltd.
- ITC Ltd.
- NMDC Ltd.
- Sun TV Network Ltd.
- Oracle Financial Services..
- Procter & Gamble Hygiene Ltd…
- …..there are 100 such debt free companies….
Click here to get a list of 100 debt free companies with details like “debt minus cash”, “Debt Equity Ratio” etc.
[P.Note: Finance-Banking stocks necessarily has “Debt minus Cash” component in negative due to nature of their business]