Bloomberg, quoting CreditSights, a unit of the credit ratings agency Fitch, reported this week that the Adani Group is “deeply over leveraged”, and may, “in the worst-case scenario”, spiral into a debt trap and possibly a default.
Gautam Adani, founder of the giant business conglomerate, is the richest man in Asia, according to Bloomberg. The report noted that the Group has been making aggressive investments that are predominantly funded with debt, putting pressure on its credit metrics and cash flow.
“We see little evidence of promoter equity capital injections into the group companies, which we feel is needed to reduce leverage in their stretched balance sheets,” the Bloomberg report quoted CreditSights as saying in its report. The Adani Group did not comment on the CreditSights assessment, according to the Bloomberg report.
When is a company ‘over leveraged’?
A company or business is said to be “over leveraged” if it has unsustainably high debt against its operating cash flows and equity. Such a company would find it difficult to make interest and principal repayments to its creditors, and may struggle to meet its operating expenses as well. In the latter case, the company may be forced to borrow even more just to keep going, and thus enter a vicious cycle. This situation can ultimately lead to the company going bankrupt.
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Why does a company have to take on debt?
Just as a loan from a bank can help an individual buy a home or a car, lead to an improvement in her quality of life, and perhaps enable her to contribute better to her society in tangible and intangible ways, debt can help a company grow and expand, create more jobs and make profits, and ultimately contribute to the GDP growth of the country itself.
However, it is critical for companies to manage their debt well, just as it is critical for individuals to make timely repayments of their loans. While taking on debt is sometimes a better option to raise capital than, say, issuing stock, which would dilute ownership, borrowing more than they can repay lands companies in trouble.
Companies typically borrow in anticipation of future demand, and when that does not work out, they find it difficult to sustain the debt burden. This is the reason many real estate companies that took on debt in anticipation of a housing boom went bust when the apartments they planned or built did not sell. A company that is less leveraged is better placed to manage situations in which revenues fall.
What happens when a company is over leveraged?
Being over leveraged constraints companies’ growth plans. If payments are not paid in time, it may lose assets, which may be taken over by creditors, who may also launch legal proceedings to recover their money. The inability to repay existing debts puts limitations on future borrowing by the company. Also, an over leveraged company will find it extremely difficult to get in new sets of investors, all of which will add up to further diminish its financial present and future.
Bloomberg’s report, however, noted that in Adani’s case, “CreditSights’ analysts…said they draw “comfort” from the group’s strong relationships with banks as well as the administration of Indian Prime Minister Narendra Modi”. Also, “the (Adani) group has a “strong track record of churning out strong and stable companies” through its flagship, Adani Enterprises Ltd., and has built a portfolio of “stable infrastructure assets tied to the healthy functioning” of the Indian economy, Bloomberg said.