While companies with high leverage are tempting bets because they trade at high betas, meaning they tend to climb higher when stocks rise, the flipside is that they also fall further when share prices drop.
Let us take a look at high leverage stocks from the BSE 500 index.
#1 Adani Power
Adani Power share price tops the list of stocks with high financial leverage.
The company has total debt amounting to ₹650,263 m as of March 2021. Its net worth during the same period stood at ₹4,976 m.
When compared with other Adani group companies, Adani Power is saddled with huge debt.
In fiscal 2020, it incurred losses of ₹22,748 m on the back of high fuel cost, coupled with the falling rupee and high-interest cost. This year however, the company was back in black posting profits of ₹12,700 m.
Adani Power is the only Adani group stock that has opted for voluntary delisting.
With growing businesses, Adani group’s debt has also increased. Also, the Adani group has a lot of planned capital expenditure ahead which would only mean more debt.
While Adani group, led by the second richest Indian, Gautam Adani, is a contributor to nation building, its increasing debt seem to be beyond the comfort zone.
This has led to many brokerage houses not initiating coverage on these stocks.
The strategies adopted by the richest Indian, Mukesh Ambani, and the second richest were a story of contrasts. When Reliance Industries went on a deleveraging exercise to reach a zero net debt status, Adani group has embarked on a debt-fueled expansion spree.
#2 Tata Communications
Tata Communication’s total debt stands at ₹99,585 m as on 31 March 2021. During the same period, its total equity stood at ₹1,155 m.
Now, dividing its total debt by total equity would give us a D/E ratio of 86.
During financial year 2021, the Tata group company’s profit and cash flow both showed an improvement.
Due to strong cash flow generation, the company was able to lower its debt. Still, it has high debt.
Tata Communication’s net profit for fiscal 2021 stands at ₹12,537 m, a 11-year high. This also compares with a loss of ₹870 m in fiscal 2020.
#3 Mahindra Holidays & Resorts
As of March 2021, Mahindra Holidays’ total debt stood at ₹9,393 m. While the debt is comparatively low, its net worth is also low at ₹847 m.
This gives a D/E ratio of 11.
Recently, an insider of Mahindra Holidays & Resorts India, Akhila Balachandar, sold ₹3.1 m worth of his shares for ₹306 apiece. It represented 100% of his holding.
Mahindra Holidays & Resorts, a part of the leisure and hospitality sector of the Mahindra group, offers family holidays primarily through vacation ownership memberships. Started in 1996, the company's flagship brand ‘Club Mahindra’ has over 250,000 members.
#4 Adani Green Energy
It’s no surprise that another Adani group company is in the list of high leverage companies.
Adani Green Energy’s total debt as of March 2021 stands at ₹238,740 m.
Its net worth during the same period is ₹22,000 m.
Dividing its total debt by net worth would result in a D/E ratio of 11.
Back in March 2021, Adani Green had raised US$1.35 bn debt for its under-construction renewable energy projects via definitive agreements signed with a group of twelve international lenders.
Investors seem to be confident on the Adani group. They believe companies will be able to make repayments accordingly.
But here’s the concern. Investors were also confident on Reliance Power and Reliance Infra in 2015 and 2016. They had similar leverage metrics and enjoyed market confidence. Yet they were derailed when group firm Reliance Communication collapsed.
Another concern is that the sectors Adani group is expanding into (airports and data centers) are high leverage businesses where history is not encouraging.
GMR and GVK groups, which won prized airport privatisation contracts in 2005, did not recover from their debt fueled expansion. Tulip Telecom also became unviable under the weight of debt to build Asia’s largest data centre in Bengaluru.
Mangalore Refinery & Petrochemicals (MRPL) was set up as a joint venture (JV) between the AV Birla Group and Hindustan Petroleum Corporation (HPCL).
It operates a refinery at Mangalore, with a nameplate capacity of 15 m metric tonne per annum (MMTPA).
As of March 2021, MRPL’s total debt stood at ₹238,333 m while its net worth stood at ₹42,481 m.
Thus, MRPL has a debt to equity ratio of 5.6.
MRPL has posted huge losses in the past because of high debt service commitments.
Its subsidiary, ONGC Mangalore Petrochemicals (OMPL), has high debt levels (approximately ₹75,500 m as of December 2020). MRPL is set to merge with OMPL, which is expected to be completed by financial year 2022.
Rating agency ICRA believes even though MRPL has incurred large cash losses and has large repayment obligations going forward, the same are expected to be met partly from accruals and partly refinanced.
#6 TVS Motor Company
TVS Motor Company commands a debt to equity ratio of 3.1 with total debt amounting to ₹119,307 m and net worth amounting to ₹38,266 m.
The company gave 16.1% return on equity to shareholders in fiscal 2021. While, TVS Motors does use a high amount of debt to increase returns, its ROE is quite low, even with the use of significant debt.
TVS has committed ₹10 bn to manufacture electric vehicles (EVs) under a separate vertical. The company has set up a dedicated factory for the manufacturing of EVs, which it says is scalable.
Which other stocks have high leverage?
Because banks and financial institutions tend to have higher debt as they borrow capital in order to lend, they are excluded from the above list.
However, if we do include them, the list would be filled up with them.
Have a look at the table below which shows other stocks, including banks and finance companies, with high financial leverage.
Why you should look for debt-free companies
Debt plays an important role in a company’s financial performance.
Companies with high debt equity ratios are riskier. This is because interest payments on debt must be made at regular intervals.
If the firm is unable to generate enough cash to service its debt, it's at risk of bankruptcy.
That is why investors often look at debt-free and moated businesses.
Debt-free companies don’t have to worry much about a slowing economy or an increase in interest rates.
However, a high debt to equity ratio can also be good sometimes because it shows that a company can service its debt obligations and is using the leverage to increase equity returns.
On the other hand, if the debt equity ratio gets too high, the cost of borrowing will zoom.
Investors require financial analysis to back up the risks they take in the stock market. Ratios like the debt equity ratio provide a picture of the company's capital structure.