There is a growing opinion that most non-performing assets are not derived from faulty products or ineffective marketing, but poor financial structuring.
Most problems begin with a mismatch between the time that a company thinks it will be able to effect commercial production and the time that this actually happens. The second problem transpires when the company needs to begin debt repayment and interest service while the project for which the funds were raised has not yet got off the ground, creating a working capital trap for which the company needs to approach the banks again (this time for more expensive funds).
The one company that comes across as an amazing contrarian is the Kolkata-based Ramkrishna Forgings Limited (RKFL). The company is engaged in commissioning a Rs 700-crore expansion of its forgings capacity - from 70,000 tonnes per annum (TPA) to 150,000 TPA - expected to be commissioned in the first quarter of FY16.
What I like about the company is how it has assumed that everything that can go wrong probably will, translating into the kind of financial structure that prioritises liquidity, liquidity and liquidity.
The company financed Rs 500 crore of its Rs 700-crore project out of debt, a recipe for disaster. Now consider how the company countered this risk: It raised Rs 150 crore of the 12-year export credit agencies (ECA) debt at 125 basis points above the London inter-bank offered rate (Libor), translating into a yearly interest outflow of Rs 2 crore. Now, when you factor the currency movements, the marked-to-market gain already available to the company is probably higher than what it expects to pay in interest across the entire loan tenure - a negative cost of capital at a time when peers are complaining of high cost!
RKFL mobilised a Rs 100-crore 12-year Export-Import (EXIM) Bank loan at 12 per cent, with a ballooning repayment arrangement that will make it possible for the company to conserve cash in the early years, strengthen terms of trade, enhance profits and comfortably repay thereafter.
RKFL mobilised a $14-million International Finance Corporation (IFC) loan with a 54-month repayment moratorium (in addition to equity from IFC). Besides, the company mobilised a $10-million seven-year DBS Bank loan with a three-year moratorium.
The result is RKFL has mobilised Rs 500 crore of debt with an average eight-year tenure and an average 6.5 per cent cost even before its expansion has been fully commissioned. So what would normally have been a Rs 75-crore annual interest outflow coupled with Rs 100 crore annual debt repayment has now been moderated to Rs 50 crore of annual interest outflow and Rs 50 crore of annual debt repayment, creating just enough breathing room for the company to be prepared for any project implementation slippage - without bleeding.
That explains why even though the expansion has not yet happened, the stock has been priced up to a discounting of 20 (based on projected FY15 earnings).
Imagine pricing a stock not for what the company's product may do and where it may be sold, but for how its balance sheet has been structured.
Who is the chief financial officer at RKFL?
The author is a stock market writer, tracking corporate earnings and investor psychology to gauge where markets are not headed
