In finance, capital structure refers to the way
a corporation finances its assets through some combination of equity, debt or
hybrid securities. A firm's capital structure is then the composition or
'structure' of its liabilities. For example, a firm that sells Rs. 20 crore in
equity and Rs. 80 crore in debt is said to be 20% equity-financed and 80%
debt-financed. The firm's ratio of debt to total financing, 80% in this example
is referred to as the firm's leverage. In reality, capital structure may be
highly complex and include tens of sources.
The capital structure
analysis of cement industry is given below taking Ambuja Cements, Chettinad
Cements and JK Lakshmi Cements into consideration. The performance of the
company within the industry as well as in comparison to the selected peers is
being done. Here the industry average of the D/E ratio is taken by taking the
average of D/E values of top 5 players in the industry by market share.
Financial Leverage
It
magnifies the effects on earnings per share of changes in the level of sales.
The higher the degree of financial leverage, the more volatile EPS will be, all
other things remaining the same. Financial leverage can be defined as the
degree to which a company uses fixed-income securities, such as debt and
preferred equity. With a high degree of financial leverage come high interest
payments. As a result, the bottom-line earnings per share are negatively
affected by interest payments. As interest payments increase as a result of increased
financial leverage, EPS is driven lower.
As
mentioned previously, financial risk is the risk to the stockholders that is
caused by an increase in debt and preferred equities in a company's capital
structure. As a company increases debt and preferred equities, interest
payments increase, reducing EPS. As a result, risk to stockholder return is
increased. A company should keep its optimal capital structure in mind when
making financing decisions to ensure any increases in debt and preferred equity
increase the value of the company.
1) AMBUJA CEMENTS
Capital
Structure(in crores)
|
|||||
|
Dec
'12
|
Dec
'11
|
Dec
'10
|
Dec
'09
|
Dec
'08
|
Shareholders'
Fund
|
8797.41
|
8,069.44
|
7,330.10
|
6,470.90
|
5,672.87
|
|
|
|
|
|
|
Total
Debt
|
49.63
|
49.36
|
65.03
|
165.7
|
288.67
|
|
|
|
|
|
|
D/E
Ratio
|
0.005641
|
0.006117
|
0.008872
|
0.025607
|
0.050886
|
Industry Average
|
0.445214
|
0.601223
|
0.635774
|
0.769121
|
0.880177
|
Comments
·
Ambuja Cements Ltd. is India’s third
largest cement company with a total capacity of about 27 MMTPA. Ambuja Cements
Ltd commands a market share of 9.6% compared to 18.3% of Ultratech Cements and
10.3% of ACC.
·
Ambuja Cements started out this decade
with a Debt/Equity ratio of 1.68, this debt was raised to finance its
acquisition of stake in ACC. The company has thus over the years
decreased its Debt and hence Interest cost. All the capital expansion
programs of the company have mostly been financed through its own earnings than
raising of new debts or issuance of new equity.
·
The company through years has attained a
comfortable debt position it is now only 0.5% of the total equity share
capital. This means that the company can pay all its debtors 200 times with its
shareholder wealth.
·
In comparison with the industry average,
the debt-equity ratio is very low. This means that the company is financing the
expansions and other operational expenses through its own earnings as it has
not issued more shares in the past 5 years that much. Since the company’s
debt-equity ratio is far lower than the average, company pays more tax if the
for the new investments as it is not leveraging. Company can leverage a part of
its expense in the form of debt so that a lot of money can be saved as tax
benefit. This is because of the fact that, the tax payed to debtors is less
than the corporate tax.
|
Dec
'12
|
Dec
'11
|
Dec
'10
|
Dec
'09
|
Dec
'08
|
Total
Assets
|
12457.18
|
8,118.80
|
7,395.13
|
6,636.60
|
5,961.54
|
Total
Equity
|
8797.41
|
8,069.44
|
7,330.10
|
6,470.90
|
5,672.87
|
Net
Profit
|
1293.21
|
1,227.49
|
1,262.97
|
1,216.84
|
1,389.71
|
ROA
|
0.103812
|
0.151191
|
0.170784
|
0.183353
|
0.233113
|
ROE
|
0.146999
|
0.152116
|
0.172299
|
0.188048
|
0.244975
|
Financial Leverage Index
|
1.416005
|
1.006117
|
1.008872
|
1.025607
|
1.050886
|
·
The above table indicates some important
ratios that will measure the capital structure.
·
Financial
Leverage Index:
Financial Leverage Index
= ROE/ROA
This is a measure which
shows the usefulness of debt financing. Since it is more than 1 for all years
or the value increases from 2008 to 2012, means that ROE exceeds ROA. This
shows a favourable use of debt financing.
·
Here it is observed that the return on Equity is reducing from 24.4% in
2008 to 14.7% in 2012. This is not a good sign for the company as the higher
return for shareholders is the main motive of any company. So the company
should leverage more and use debt financing for its future plans to increase
the shareholders’ returns to an optimum amount.
2) JK LAKSHMI CEMENTS
Capital
Structure(in crores)
|
|||||
|
Mar '12
|
Mar '11
|
Mar '10
|
Mar '09
|
Mar '08
|
Shareholders' Fund
|
1,175.19
|
1,046.33
|
1,020.70
|
831.25
|
642.43
|
Net Profit
|
108.78
|
59.13
|
241.13
|
178.59
|
223.67
|
Total Debt
|
914.59
|
996.99
|
903.68
|
686.74
|
694.88
|
Return on Debt
|
0.11893854
|
0.059309
|
0.266831
|
0.260055
|
0.321883
|
Cost of Debt
|
0.08325698
|
0.041516
|
0.186782
|
0.182038
|
0.225318
|
D/E Ratio
|
0.77824862
|
0.952845
|
0.885353
|
0.826153
|
1.081643
|
Industry Average
|
0.44521381
|
0.601223
|
0.635774
|
0.769121
|
0.880177
|
Comments
·
Here, it is observed that the total
accumulated shareholders’ fund getting increased year by year and the debt of the
company is also increasing.
·
D/E ratio is well above the industry
average which is not advisable. This shows that, the company is dependent on
debt for its operations or expansion plans. Even if the D/E ratio is very below
the normal standard of 1, as the industry is more of an equity financed
industry, the company should follow more of a equity financing than debt
financing.
·
The profit of the company is decreasing
at a normal rate. The cost of debt has decreased from 22% to 8% which is a
positive thing for the company. This shows that the riskiness of the company
has reduced.
·
The company’s dependence on debt has
increased by about 30% within 5 years. This shows that the company is depending
on debt financing for operations or capacity expansion plans.
|
Mar '12
|
Mar '11
|
Mar '10
|
Mar '09
|
Mar '08
|
Total Assets
|
2,089.78
|
2,043.32
|
1,924.38
|
1,517.98
|
1,337.32
|
Total Equity
|
1,175.19
|
1,046.33
|
1,020.70
|
831.25
|
642.43
|
Net Profit
|
108.78
|
59.13
|
241.13
|
178.59
|
223.67
|
ROA
|
0.05205333
|
0.028938
|
0.125303
|
0.11765
|
0.167252
|
ROE
|
0.09256376
|
0.056512
|
0.23624
|
0.214845
|
0.348162
|
Financial Leverage Index
|
1.77824862
|
1.952845
|
1.885353
|
1.826141
|
2.081659
|
·
The above table shows the return on
equity and asset. Here the return on equity is steadily decreasing from 34.81%
to 9.25% within a span of only 5 years. This is not a favourable sign for the
company.
·
Total equity capital raised by the
company is almost doubling in 5 years. But the return percentage reduces.
·
Though the Financial leverage index
ratio is well above 1, it is observed that it is reducing over the years. The
danger here is that, the profit of the company is also decreasing over the
years. Here ROE exceeds ROA which means that, the company is in a favourable
side of debt financing.
·
As the percentage of debt in the capital
structure is increasing over the years, it is obvious that company is using
debt financing more.
3) CHETTINAD CEMENTS
Capital
Structure(in crores)
|
|||||
|
Mar '12
|
Mar '11
|
Mar '10
|
Mar '09
|
Mar '08
|
Shareholders' Fund
|
1,080.41
|
925.71
|
863.72
|
355.15
|
392.49
|
Total Debt
|
989.28
|
896.06
|
758.87
|
997.03
|
436.19
|
Net Profit
|
188
|
75.17
|
96.63
|
-4.21
|
163.77
|
Return on Debt
|
0.1900372
|
0.083889
|
0.127334
|
-0.00422
|
0.375456
|
Cost of Debt
|
0.13302604
|
0.058723
|
0.089134
|
-0.00296
|
0.262819
|
D/E Ratio
|
0.91565239
|
0.967971
|
0.878606
|
2.807349
|
1.11134
|
Industry Average
|
0.44521381
|
0.601223
|
0.635774
|
0.769121
|
0.880177
|
Comments:
·
Here from the table above, the capital
structure of the company remained almost same even though the shares of each
got reversed over the span of 5 years. Both equity as well as debt increased by
more than 200% in the capital structure. This shows that the company has grown
tremendously over 5 years.
·
Return on debt and cost of debt are
increasing over the years. Shows that the riskiness of the company is increasing.
·
The D/E ratio is well above the industry
average even though they managed to bring it below 1. This is not promising for
the company. They can still pay all the debtors with the capital it has raised
by equity.
|
Mar '12
|
Mar '11
|
Mar '10
|
Mar '09
|
Mar '08
|
Total Assets
|
2,069.69
|
1,821.77
|
1,622.59
|
1,352.18
|
828.68
|
Total Equity
|
1,080.41
|
925.71
|
863.72
|
355.15
|
392.49
|
Net Profit
|
188
|
75.17
|
96.63
|
-4.21
|
163.77
|
ROA
|
0.09083486
|
0.041262
|
0.059553
|
-0.00311
|
0.197628
|
ROE
|
0.17400802
|
0.081203
|
0.111877
|
-0.01185
|
0.417259
|
Financial Leverage Index
|
1.91565239
|
1.967971
|
1.878606
|
3.807349
|
2.11134
|
·
The above shown table gives the return
on equity and assets as well as the financial leverage index.
·
The company is managing to increase its
profits even though it incurred a loss in the year 2009.
·
The ROA and ROE are showing an
increasing trend.
·
Financial leverage index is well above
one, shows favourable debt financing.
PEER
COMPARISON
1)
Debt
as a percentage of Equity
·
Ambuja Cements keeping a low D/E ratio
over the years.
·
The D/E ratio of Chettinad Cements
showing fluctuations over the years, keeping it low from 2010.
·
JK lakshmi keeping the ratio below the
safe value of 1 but is well above the industry average.
·
The industry average keeps reducing
showing that, the companies are depending less on debt financing with changing
economic conditions.
Influence
of capital structure on Industry
As the industry is very
much capital intensive, it incurs a lot of initial investment for the companies
in building huge plants as well as for the machineries. Each company has raised
a huge initial capital from the shareholders and then later they have raised
money from lenders for expansion plans as well as operations, except in the
case of Ambuja cements in which they are using their earnings for operations as
well as expansion plans as they have very low debt compared to the
shareholders’ fund in their capital structure.
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