IVRCL Is An Excellent Example Of All That Is Wrong With Many Indian Corporates  

Last week, a portion of a flyover being built in an old part of Kolkata collapsed, killing 27 people. The flyover was being built by IVRCL.

The company reacted immediately to the tragedy. AGK Murthy, Director (Operations) of the company told The Hindu: “It is for the first time in the history of the company that such an incident has occurred. We are unable to comprehend at this stage what could have happened. It is beyond our thinking. It is like an act of god.”

An “act of god” is basically a legal term associated with events outside human control. Natural disasters like floods, earthquakes, cyclones etc are good examples.

Hence, the question is, can the collapse of part of the flyover in Kolkata be called an “act of god”? The flyover clearly did not fall because of a natural disaster. Experts, who understand such things, are of the opinion that it was a design failure that caused the fall. Several experts said this to the Hindustan Times.

Also, much of the analysis on the issue in the media has missed out on the poor financials of IVRCL. The financial situation of the company has deteriorated considerably over the years. A few graphs that follow clearly show us that.

Let’s start with the debt to equity ratio of IVRCL. As can be seen from the above chart, the debt to equity ratio of the company has been on its way up from March 2007 onwards. In fact, as of 31 March 2015, the debt to equity ratio of the company stood at 12:1. Hence, the total debt of the company was more than 12 times its shareholders’ equity or networth.

What does this mean? This means that the borrowings of the company were more than 12 times its capital (or its own money or the skin in the game) in the business. The ratio is extremely high. In the normal scheme of things, lower the debt to equity ratio of a company, the better it is placed from a risk perspective. Its chances of being able to continue to pay the interest on the debt are higher.

The question to ask is how did the company reach this stage?

A simple explanation for this lies in the fact that the company borrowed big-time to expand. But this expansion did not generate an adequate amount of sales. Take a look at the following chart. The sales of the company have fallen over the years.

In fact, the total sales of the company have been falling over the last few years. On 31 March 2015, the total sales stood at Rs 3,927 crore, or around half of where it stood as on 31 March 2012.

Now take a look at the following chart. The blue dots represent the sales of the company and the orange dots the total debt. As the debt of the company went up, the sales also went up, until they started falling.

Falling sales, led to a fall in the net profit of the company. This happened because the debt that the company had taken on still needed to be serviced. The interest on the debt had to be paid. As the interest on debt kept mounting up (the orange dots in the following chart), the net profit of the company kept falling (the blue dots in the following charts). In fact, the company has been loss making over the last few years. For the year ending 31 March 2015, the company made a loss of Rs 1,568 crore.

Further, the company continues to make losses. During the period 1 April 2015 to 31 December 2015, the company made losses of Rs 797 crore.

As the total borrowings of the company went up, its sales went down. The idea behind borrowing, should have been to expand the business of the company, so as to increase sales as well as profit. The increased sales would have then allowed the company to pay the higher interest on the debt. The higher profit would have added to the higher net worth or shareholders’ equity.

The profit after paying dividend (if any) is retained by a company and is added to its net worth or shareholders’ equity. Hence, as the profit of IVRCL would have gone up, its net worth would have gone up as well. This would have kept the debt to equity ratio of the company under control.

But this is how things should have played out theoretically. The fact of the matter is that they did not. In fact, the losses made by the company over the last few years have been adjusted against the net worth and the net worth has come down dramatically during the period.

It also needs to be pointed out here that IVRCL, like many other companies, got carried away in the era of easy money that prevailed between 2002 and 2008, and ended up borrowing much more than it could perhaps be able to repay.

Take a look at the following graph which charts the rate of interest that IVRCL has paid on its debt over the years. The rate of interest that the company paid on its debt in the financial year ending 31 March 2006, stood at 4.85 percent. This low rate of interest encouraged the company to increase its borrowing at a rapid pace.

As on 31 March 2005, the total debt of the company had stood at Rs 336 crore. By 31 March 2012, this had jumped up nearly 18 times to Rs 6,005 crore. Like many other infrastructure companies, IVRCL also had tried to cash in on an era of easy money and is now paying for the same.

In fact, on this and other counts, many other corporates are facing a similar set of problems because of having borrowed too much during the go-go years.

It is worth asking here: how could a state government allow a company with a debt to equity ratio of 12:1 to continue building a flyover? Any company in such a scenario would be really tempted to compromise on quality, in order to ensure that it could push up its profits and if not that, at least limit its losses.

IVRCL has said that “all necessary processes and quality steps have been taken as per standard operating procedure”. This needs to properly investigated.

This article was first published on Equitymaster.