Indian steel industry is heading towards another crisis

Financing is the most indispensable function of a business organisation for its existence, survival and growth. Whether carrying out day to day operations or investing in capital assets for further generation of income, finance infuses lifeblood in all these preconceived objectives (Gupta 2005). India being fast emerging economies of the world expects a lot from its industrial sector. The development of a country is well measured from the contribution of its industrial sector to country’s GDP (Jain & Khanna 2011).The financial structure of  Indian steel industry is mainly composed of two modes of financing; equity and debt where equity represents owner’s funds. Debt comprises of borrowings from banks in the form of loans, debentures, securities from foreign institutional investors commercial papers and certificate of deposit. The choice of source of finance depends upon the company’s position besides purpose of acquisition and allocation of funds  (Gupta 2005).

Current scenario of the Indian steel industry

Debt financing has become a commonly used source of finance by the companies in the Indian steel industry especially through banks. The time period ranging from 2010 to 2014 has observed extensive debt procurement by  the largest Indian steel industry. The global decline in the steel price due to economic slowdown in major economies. Also excess production from China has adversely affected the prices of steel in the Indian steel industry hence the growth of the sector. As per the report of Investment Bank Credit Suisse the total debt of major steel industries is around $15 billion which is 15 times higher than their collective operating profit (Credit SUISSE 2015). Increasing debt of the  Indian steel industry has direct impact on the Indian banking sector as banks are the major lenders. The declining profits and rising debt in the Indian steel industry has added further distress in the banks which are already in pressure to clear of their Non-Performing Assets (Livemint 2015). Three major companies in Indian steel industry that are going through the difficult phase of declining profit have been analysed.

Jindal Steel and Power Ltd.

Beginning with Jindal Steel and Power Ltd. which is one of India’s top Steel Companies was founded in the year 1952 and whose product portfolio comprises markets across the value chain of steel. Over viewing its financial structure, the company’s debt equity ratio that is the proportion of noncurrent liabilities bearing fixed interest obligation with respect to equity share holders funds, has jumped to 2.26:1 in 2015. The ratio was 1.39:1 in the year 2011. The total debt of the company for the year 2015 stood at $167175.82 million from $56316 million in the year 2011. This change indicates Jindal’s increased reliance on debt financing over the shareholder’s funds. However, the debt financing has not created many benefits to the company since the earnings before interest and taxes have fallen from 44.20% in the year 2011 to -48.68% in the year 2015. The profit of the company for the year 2015 stood at $11497.91 million which is a sharp decline from the year 2011 which stood at $13168 million. Thus, a negative correlation has been observed between increase in debt and earnings of the company.

Besides this, the risk of fixed interest obligation has increased over the years. In FY2011 interest coverage ratio stood at 6.78 times which dropped to 0.72 times in the year 2015. The sharp decline in profits could be attributed to enormous rise in interest payments of the company being a prime reason. The total interest payment grew to $13706 million in the year 2015 from mere $2487 million in the year 2011.  Nevertheless, the company’s ability to meet short term obligation has been improved since the current ratio in the year 2011 which stood at 0.78:1 and rose to 0.88:1 in the year 2015 (Jindal Steel and Power Ltd. 2016).

Debt equity ratio and Earnings
Debt equity ratio and Earnings before interest and taxes growth of Jindal Steel and Power Ltd. from 2011 to 2015 (Source: Jindal Steel and Power Ltd. 2016).

Jaypee Associates, a giant player in the Indian steel industry

Jaypee Industries is a conglomerate of industrial infrastructure, steel, construction, cement, power, hospitality, sports, education and real estate and was founded in the year 1979. It is fourth largest cement manufacturer and the largest hydro power private sector company currently in operations. Examining its financial practices, it has been observed that the company’s borrowings have substantially increased from the year 2011 which stood at $313912.612 million and rose to $ 506816.463 million in the year 2015. The debt equity ratio for the year 2011 stood at 4.01:1 and was raised to 5.25:1 in the year 2015. However the net profit margin of the company declined from 20.58% in the year 2011 to -3.54% in the year 2015. The consolidated loss for the year 2015 amounted to $7333.6 million while in the year 2011 there was a profit of $8362.5 million. Thus, again a negative correlation is pictured between increased debt components in the financial structure of the company with its profits.  The reduction and negation of profits could be largely attributed to increase in interest expense which became six times in the year 2015 from the year 2011. Other major reasons include increased business costs in infrastructure investment and global slowdown. The finance cost in the year 2011 was $ 9645 million which reached $54236.6 million in the year 2015.

Besides, financial risk in term of interest payment out of earnings has been further increased on account of reduced interest coverage ratio which stood at 2.135 times in the year 2011 and fell to 1.04 times in the year 2015. Furthermore, the company’s ability to meet its short term liabilities has been also reduced. In fact the current of the company which earlier stood at 3.38:1 in the year 2011 fell to 0.74:1 in the year 2015 (Jay Prakash Associates 2016).

Debt equity ratio and net profit margin of Jaypee
Debt equity ratio and net profit margin of Jaypee from 2011 to 2015. (Jay Prakash Associates 2016).

Tata Steel losing market to Chinese steel industry

Lastly, Tata steel Company established in the year 1907 is a pioneer in the Asian Steel industry and ranks among the top ten global steel producers in the world. For the year 2014, its revenue stood at $1114612.5 million and lists in Fortune 500 Companies (Tata Steel Ltd 2016). Investigating company’s financial structure, it is brought into notice that its debt equity ratio has fallen from the year 2011 which stood at 0.59:1 to 0.41:1 in the year 2015. The total debt of Tata Steel for the year 2015 stood at $247989 million while in the year 2011 it stood at $202833 million with financial risk increasing simultaneously owing to the fact that the interest cover in the year 2011 stood at 6.63 times and dropped to 5.31 times in the year 2015. Moreover, the earnings before interest and tax margin too has faced a sharp decline over the years since the EBIT margin which earlier stood at 36.09% in the year 2011 went down to 22.51% in the year 2015. The company’s profits for the year 2015 stood at $57307.99 millions while in 2011 the profits stood at $61103.84 million. The fall in profits could be attributed to rise in interest expense which stood at $17585.51 million in the year 2015 an increment over the year 2011 which used to be $13747.83 million besides global financial crises, Euro zone slump, huge exports by China, increase in energy prices and other business costs being other reasons. However, the liquidity position of the company has even worsened owing to its current ratio which stood at 1.38:1 in the year 2011 and dropped to 0.71:1 in the year 2015 (Tata Steel 2016).

EBIT margin of Tata Steel from 2011 to 2015
EBIT margin of Tata Steel from 2011 to 2015 (Tata Steel 2016).

Among the three companies analysed it seems that the Jindal Steel and Jaypee Associates are facing more worse condition as compared to the Tata Steel. The Tata Group are engaged in other business which are profitable. For Jaypee Assocites and Jindal their other business such as cement and real estate are also not performing well. So if required measures are not taken by these companies to cut their cost and increase revenue the Indian banks may face another phase of rising bad loans which if happens will be worse than the previous ones.

Indian steel companies should reduce their expenditure to overcome debt crisis

In the net shell, it could be well concluded that debt financing has landed the biggest of Indian corporate  in hot waters since not only the companies have reduced earnings over the years corresponding to the increased borrowings that has infused heavy interest obligations running out of their earnings and thus negating all their revenues. Three companies in Indian steel industry has been analysed are Jindal, Jaypee and Tata steel all present a dismal performance over the last five years where on one hand their earnings have falling trend while the debt proposition is constantly increasing. However, Tata steel has well realized this fact and thus have resorted to equity and that is why their debt equity ratio is now moving to a decline. However, the other two companies have steel not realized the threat and perhaps have been drowning in the quiver of debt. Therefore, in order to save from even worse situations and running insolvent its high time for them to reframe their capital structure. Henceforth, in order to improve their financial statement figures’, the companies must undo their borrowings policy and should shift to other modes of financing so as to improve their earnings and thus create a sound financial structure with better returns.

References

  • Credit SUISSE, 2015. India Steel Sector, Mumbai.
  • Dubey, R., 2015. Corporate India’s heavy borrowings could slow down economic recovery. Business Today.
  • Gupta, S., 2005. Management Accounting and Business Finanace 13th ed., Chandigarh: Kalyani Publishers.
  • Jain, T.. & Khanna, O.., 2011. Business Economics, Delhi: VK Global Publications Pvt. Ltd.
  • Jay Prakash Associates, 2016. JAIPRAKASH ASSOCIATES EQUITY RESEARCH.
  • Jindal Steel and Power Ltd., 2016. Jindal Steel and Power Ltd.- Financial Ratios.
  • Livemint, 2015. A troubled time for India’s steel industry. HT Media Pvt ltd.
  • Tata Steel, 2016. Tata Steel Ltd.- Finanacial Ratios.
  • Tata Steel Ltd, 2016. About Tata Steel.
Isha Mahajan
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