Jitendra Kumar Gupta
Highlights:- Government taking out partial cash could prove to be beneficial
- Too much cash destroying value for shareholders
- Buyback and dividend to create value
- Little borrowing will reward capital and increase responsibility
After listing on the exchanges, Hindustan Aeronautics (HAL) has been in the news for all the wrong reasons including the government's withdrawal of nearly Rs 15,000 crore via buyback and dividends. The cash-rich HAL recently raised close to Rs 1,000 crore just to pay salaries to its employees.
While it managed to grab headlines, the truth is what is happening should only benefit the company and its shareholders.
Little borrowing makes sense
Drawing borrowed funds for salaries is only an accounting entry. Had the loan been taken for working capital, the term salary would not have emerged. At the end of September 2018, the company was sitting on receivables of close to Rs 10,000 crore on annual sales of Rs 18,623 crore.
The infusion of little debt or Rs 1,000 crore debt on a net worth of over Rs 12,621 crore should make little difference. Assuming a 10 percent interest rate on the fresh debt, the annual interest cost would be about Rs 100 crore, which is nothing compared to FY18 profit before interest and tax of close to Rs 2,568 crore. The effective interest coverage works out to 26 times, which is quite strong.
Recently, an incident of misappropriation of Rs 5.47 crore was detected in HAL, which was referred to the vigilance department and a few company officials were booked by the CBI. Now, with the company raising debt, it will come under the scanner of credit rating agencies also, thus increasing its responsibilities.
Finally, the business has a very high competitive advantage with predictable cash flows. Even if it borrows at about 9 percent (it is tax deductible) and generates 20-25 percent on these borrowed funds (current core RoE in excess of 25 percent), the ratios will improve and thus reward capital.
Correcting the math
At the end of March 2018, the company had cash equivalent of about Rs 6,500 crore mostly parked in the bank. Last year, it earned other income of Rs 761 crore or 11.7 percent of cash. Obviously, the bank deposit must be yielding in the range of 9-10 percent, which after deducting tax would be far lower thus making little sense to hoard cash. So, core return on equity at 25 percent is much higher than the yield on cash, in which case, the company should rather deploy cash in the business or return it back to shareholders.
Too much cash, better ways to use
As of March 2018, the company’s net worth stood at about Rs 12621 crore. Looking at the balance sheet, close to 50 percent of its equity capital is deployed in cash and bank balances which are yielding nothing. If the cash is returned to the shareholders as dividends, they can park it in better yielding investments.
If the cash is to be kept in the bank, investors can choose to do it at will. Even a buyback at a lower price (the stock currently trades at Rs 778 as against the IPO price of Rs 1,240) will not only be a tax-efficient way of creating value for existing shareholders but also lead to the long term benefit as the equity shrinks.Moneycontrol Research page