Debt-free firms make up 57% of all market cap: Why Dalal Street loves them

Despite such heavy weightage in overall corporate worth, these companies account for just a quarter of revenues and assets

Dalal Street shows a special preference for companies that stay away from debt and fund their operations largely from internal accruals. Debt-free companies (on net debt basis) account for 57 per cent of all market capitalisation of listed non-financial companies even though these companies are in a minority in terms of revenues, assets and net profits.

In all, 209 non-financial companies out of a total sample of 594 companies were debt-free at the end of 2017-18 and together they accounted for 25.6 per cent of the sample companies' combined net sales, 22.7 per cent of all assets and 46.5 per cent of their net profit. 

The analysis is based on a common sample of companies that are part of the BSE 500, BSE Midcap and BSE Smallcap indices. (See table).

Tata Consultancy Services (TCS) is the largest and the most valuable debt-free company followed by Hindustan Unilever, ITC and Infosys and Maruti Suzuki.  Most of the debt-free companies are in sectors such as fast-moving consumer goods, consumer durables, IT services, pharmaceuticals and automotive. Besides, most of the Indian subsidiaries of global multinationals, including those in sectors such as capital goods, are debt-free.

In India, the total debt to the non-financial sector from all sources reached $3 trillion (around Rs 198 trillion) at the end of September 2017, against $2.4 trillion three years ago according to data from the Bank for International Settlements (BIS). This includes the non-financial corporate sector, households and the government sector.

Debt-free companies are currently valued at Rs 50.5 trillion against the combined market capitalisation of Rs 89.2 trillion for non-financial companies in the Business Standard sample. If we include companies with insignificant debt on their books — net debt less than 25 per cent of their net worth — then these cash-rich companies' share in total market capitalisation grows nearly 65 per cent, more than twice their share in corporate India's revenues and assets. 

In the real world, however, consumers, the government and companies continue to pile up debt. Globally, total debt to the non-financial sector from all sources increased to a record high of $174 trillion at the end of the September quarter, according to the BIS data. 

Analysts attribute this to the premium valuations that debt-free companies enjoy. “Debt-free companies get a premium valuation compared to companies with some debt on their books. It is due to the lower risk inherent in investing in these companies,” says G Chokkalingam, founder & managing director, Equinomics Research and Advisory Services.

The only risk that an investor takes with a debt-free company is growth risk. “An investor may not make money in a debt-free company, say, due to poor growth, but there is little chance of you losing money,” he adds.

Besides, these companies report higher return on equity and do not depend on outside sources of funding to launch new products or enter new markets. This shows in the valuations ratios of these companies. A typical debt-free company is valued at nearly four times its latest 12-month revenues and 28 times its annual profit. The corresponding valuation ratio is 1.8x and 18.1x companies with debt-to-equity ratio between zero and 0.25 times. 

However, contrary to popular perception, not all debt-free companies are from asset light sectors such as FMCG, IT services and consumer goods. Hindustan Zinc, a debt-free zinc maker, is the country’s most valuable metal company. Similarly, Shree Cement is among one of the most expensive stocks on the bourses in terms of price-earnings.

Analysts say debt-free companies enjoy greater financial flexibility to grow their business in a cyclical upturn in the economy. “When the business cycle improves, debt-free companies can continue to grow while indebted companies will use profitability to deleverage their balance sheet rather than invest in new products and markets,” says Dhananjay Sinha.

It also helps that debt-free companies are cash-positive, which means that their operations generate more cash then they use for growth and expansion. This makes them big dividend payers which attracts investors. For example, TCS is the country’s top dividend payer in the private sector. And most of the top debt-free companies (in terms of market capitalisation) are also among the biggest dividend payers in the country.

Analysts say that debt-free companies with lower risk profile become even more attractive to investors in times of low-growth and economic and business volatility. “The stable cash flows that these companies generate are even more valuable at a time when many businesses find it tough to stay profitable, let alone grow their top line and bottom line,” says Sinha. But it could also be a case of lack of investment opportunity in the economy forcing companies to sit on cash reserves or not make fresh borrowings to fund capital expenditure (capex). Corporate capex has nearly dried up in the country due to poor demand growth across sectors.