Interest monster eating company's pie

Do you know what is common between Vodafone Idea, Piramal Pharma IndiGo, GMR Airports, PVR Inox?
All these companies have reported losses in the financial year 2023… It’s not that these companies are not earning money. It means their bottom line is getting impacted… So if the revenue of these companies is increasing or the business is expanding, then what is it that is affecting their profits? Let’s understand…

Any company requires capital to operate and expand its business. If the profits from the business are sufficient for expansion, then companies don’t need to take on debt. But companies that cannot fulfill their capital requirements on their own have to seek support from investors or banks. In other words, they have to take on debt. But the question is, if any company takes on debt, is it the right thing to do? Or should it be seen as a negative thing?

The numbers reveal that the interest expenses of Nifty 500 companies have grown from around ₹1.73 lakh crore in FY18 to nearly ₹3 lakh crore by FY23. This implies an increase of approximately 73% in the interest expenses of these companies over the past 5 years. In comparison to FY22, these companies have also experienced an increase of nearly 14% in interest expenses. However, these figures do not encompass financial companies and banks.

What’s the projection?
It is expected that the trend of escalating interest expenses for corporations will persist in FY24. According to a report by India Ratings, there’s an estimated 30% rise in corporate interest expenses for FY24. The projection suggests that corporate interest expenses will reach around ₹3.38 lakh crore in FY24, from the ₹2.52 lakh crore recorded in FY22. This projection includes data from 3,365 non-financial companies. The surge in corporate interest expenses began in the second half of FY23 as the repo rate began to rise as RBI’s started rate hike cycle from May 2022. By February 2023, the repo rate went up from 4% to 6.5%. Although the RBI has maintained stable rates since then, India Ratings expresses concerns about the potential rise in corporate interest expenses in FY24 due to the likelihood of further increases in banks’ MCLR (Marginal Cost of Funds Based Lending Rate).

Impact of interest cost

Now, the crucial question is how does the interest expense impact a company’s profits, and how should investors understand it? Generally, almost all companies take on debt for their business operations. For instance, even the country’s largest company, Reliance Industries, carries a substantial amount of debt. But how can one assess the quality of debt, distinguishing between good and bad debt? The easiest way to do this is to compare a company’s annual interest expense with its profits.

If a company reports losses annually and its interest expenses are higher than those losses, you can say that the interest payments are eating into the company’s profits. Alternatively, if a company is struggling with losses due to higher interest expenses, it’s evident that the company is facing challenges because of the significant interest burden. For example, in FY23, GMR Airports paid ₹2,018 crore in interest while facing a loss of ₹752 crore. Similarly, Aditya Birla Fashion incurred a loss of ₹118 crore, while its interest payment was ₹389 crore.

How to assess good or bad debt?

As per market expert Ambrish Baliga “Investors need to look at future cash flows. If it’s not possible then you need to check whether debt is being taken for capital expenditure or working capital. If the loan is taken for working capital, then it is not good for the company’s financial health. Going ahead this can become a concern for the company. From an investment point of view, stay away from Vi because it is taking debt to run its business operations. You can invest in Indigo for long-term purposes because it is taking loans for capital expenditure.

If you are also investing your hard-earned money in the share market, then you must analyze the balance sheet of the company. 1st of all retail investors must check whether a company has debt or not. If yes then you need to look at the reason for taking debt. Also, check whether debt is eating away profits or not.