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Debt-free / Low-debt / Virtually-debt free companies



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A person who has no loans and liabilities is a free bird and flexible to do anything in regard to his finances.

Similarly, a person with debt is always in constant pressure to repay the principal as well as interest.

He has to ensure timely payment of his EMIs or else he will face the risk of his credit rating downgrade.

When it comes to companies, the same holds true.

In general, it is better to invest in companies that are debt-free or virtually debt-free.

Why should we prefer debt-free companies?

What is the difference between debt-free and virtually debt-free?

Let us find these things in the lesson today.

Rule #10: Prefer companies which are debt free or having no loans

Companies take debt (loans) for their cash needs or for projects or for business expansion.

Debt might be inevitable and necessary for some businesses.

But if a company can meet its plans from its own internal funds for expansion etc, it can be considered a good sign.

Further, because low-debt companies pay low interest, which automatically boosts profitability.

Such companies are relatively better off even when the business environment is facing a downturn

There are several sectors that can grow slowly with internal funding and without depending in debt.

For example:

Unlike factories and machinery dependent companies, service companies can be started and run without much capital.

Further, if the company takes debt and uses it properly converting it into a valuable asset, it is a good one.

Companies have to strive to clear off the debts as soon as possible.

Because

.. the more delay in repaying the loan,

.. the more interest burden falls on the company.

There are companies who pays all their profits as interest for the loans they have taken.

If the company fails to repay its interest or principal, it is a sign of stress.

For example,

JP Associates and Kingfisher have repeatedly defaulted on its payments.

Such companies should be avoided for long term investing.

Stay away from companies or groups whose debts are far beyond their repayment capacity.

Example: Adani Enterprises, Lanco etc.

If a company is consistently repaying its loan principal and repaying interest, it is a good sign.

For example,

Firstsource Solutions Limited strived for few years but consistently re-payed its loans as promised.

It is now a leading BPO company in India with global operatios.

How to find if a company is in debts or debt free?

1. The Balance Sheet of the company is the best source to determine the extent and type of loans they have taken.

2. Quarterly Reports tells us how the company is repaying and how much interest it is paying (and if the burden is reducing or not)

So, broadly speaking the sources for the information are from quarterly / annual reports which will be uploaded on company website and on stock exchange websites.

3. We get this information from Screener as well but it might not deep enough

Now, how to search for debt-free companies?

We can use a Screener called *zero-debt* for that.

Smallcase

Investors of Zerodha / Smallcase can check some interesting Small cases that are built around the concept of debt

  1. Zero Debt: Zero debt, high ROE companies with an established track record of high earnings growth
  2. Zero Debt - Low-Cost Version: Zero debt, high ROE companies with an established track record of high earnings growth
  3. Cash Cows at Bargain: Low-debt, cash-rich companies at attractive valuations

Avoid vs Prefer vs Do not

For example, in our classes, we said:

  • Avoid* companies that have debts.

and i said

  • Prefer* companies that pay dividends.

and we also said:

  • Do not* invest in penny stocks.

Understand the meaning of the words: Avoid, Prefer, Do not

  • Avoid* means: u have a choice. U generally should not invest in such companies. But if u feel that they are good, you can take a bit of risk.

For instance, Reliance Industries Limited has lot of debt.

Because they used the money to build factories (assets) and stores.

We cannot say Reliance Industries is a bad company to invest just because their loans are huge.

When a company takes fresh loans or increases its debt, you should understand if the decision is a good one or not.

In company valuations, we will learn about the impact a loan being taken will have on the share, and by how much share price changes because of this.

However, take the case of Adani group companies.

They have loans too big for them to repay even after selling all their assets.

Such companies could be risky and average investors would refrain from entering into such stocks.

The company might be performing okay or good today but if they do not reduce loans soon, their working capital gets reduced.

Working Capital = Money necesary to do daily business activities.

This means, they will soon go out of cash.

They may delay payments to vendors and suppliers.

And the business operations might halted some day.

So we can predict the future of certain companies from the moves they make today.

Debt of parent / group companies

Adani Ports and Economic Zone might be performing very well and has debt levels that are manageble by them.

If we compar the assets with respect to debt, we can say it is almost debt free.

However, Adani Ports is a part of Adani group.

On a group-level basis, the group has more debt over assets.

Do you think because of the parent company this company will get into problem ?

When parent is in trouble, kids will get into trouble sooner or later.

So, here is our new rule

Rule #23: Avoid investing in more than one stock belonging to the same group of companies (or promoters)

Should we see on overall group basis ?

Better to have a broader perspective when ever possible.

Our investments grow well when there are less hurdles or pressures to the company.

If invested in a large company with many subsidaries, look at numbers and statistics at the consolidated level.

If invested in a small company with not many subsidaries, look at numbers and statistics at the standalone level.

Example:

Should we check the debt levels of Reliance Industries Limited and Reliance Defence and Engineering Limited?

Actually speaking, Reliance Industries belongs to Mukesh Ambani

and Reliance Defence belongs to Anil Ambani.

So technically speaking, both are from different group.

An ideal comparision is ADAG group which includes RCOM, RelInfra, RelCap, Rel Defence etc.

Examples of Quality debt free companies

For instance, you might want to look at Infosys

https://www.screener.in/company/INFY/consolidated

No borrowings for the last 11 years or so.

What is meant by "virtually debt free" company?

Company has cash reserves in excess of the loans it has taken. Companies take loan for saving tax or for maintaining some working capital cash flow obligations. Such comes are called virtually debt free because they can offset their cash reserves with outstanding loan at any point of time.

Cupid is virtually debt free.

Cash Reserves of Rs. 25.01 cr vs Borrowings of 0.88 + Other Liabilities of 13.66 cr

Relation between Debt and Assets

When companies raise money in the form of loans (debt), they attempt to create some assets.

This is because, they use the funds to procure land, machinery etc.

So, there will be a correlation between debt and assets of the company.

Examples of Debt-free companies

Conclusion

We know that Infrastructure and Industrials companies require huge investments and debt is inevitable in most cases. Hence these companies have high debt and high assets.

On the other hand, IT companies are mostly debt-free and have huge cash reserves but are light on assets too.

Hence, debt levels alone cannot be the lone decision factor in investing.

When debt is inevitable for the business, consider those companies whose debt is less than 30% of equity.

Of course, there is no specific number to the acceptable debt levels.

We need to check as to how the company is using the money, is the debt manageble or not, can the company repay the debt and honor timely payment of interest? What is the Debt / Equity Ratio of the company etc.

Assignment

  1. Check your portfolio and check their debt / loan aspect.
  2. Which companies have huge debt and which are debt-free companies?
  3. What is the company doing to repay the principal and debt?
  4. Amongst listed companies on the stock exchange, identify 5 debt-free companies.

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