BATA DEBT?

DEBT FREE
BATA has been the largest footwear brand in India. Contrary to popular believe its not an
Indian brand and its headquarters is located in Switzerland. It has upwards of 1600 stores and
is present in about 70 countries. It has a turnover upwards of 3000 Crore and has a profit of
about 300 crore.
To give you a perspective of how good BATA has been over the last 10 years, here’s a
glimpse.
If you would have invested RS. 10,000 in BATA in the year 2011, today, its value would be
Rs. 82,000 at a CAGR of 23%, which is a monumental figure showing that the company has
given back 8X.
BATA is a Debt-free company.
“Instead of focusing on where you can make 500% in the next 6 months, invert that and find
situations where you can’t lose over the next few years. The latter is often where you will
find the next multi-bagger.”

This quote by Ian Cassel is really worth a billion dollars. Many times, investors keep running
behind higher return-generating assets, but truth be told, the real treasure is in finding where
you can’t lose wealth in the long run! And one such criterion to filter out stocks is Debt.

First thing first, the capital structure of any company mainly comprises equity & debt. A
company can forgo the debt part and operate only on the share capital, but the other way
round is practically not possible. So if the debt is avoidable, do companies with zero debt
thrive? Yes. BATA is one such example. Or at least this was the case till the last 2 years. A
big change in the last 2 years that was seen was the introduction of Debt to the company.

People often have a split opinion about debt injection in companies.

To understand that, we have to understand what debt in company means.

A company that either hasn’t borrowed funds from third parties like banks, financial
institutions and debt securities to carry on its operations or has repaid any such credit
borrowed in the past, is known as a Debt-free company. In other words, it means that a
company's only source of funds is the share capital.

There is another similar concept known as Net debt-free company, also called the virtually
debt-free company. For instance, if a company currently has a debt of Rs.50 crore and a cash
balance of Rs.10 crore, the net debt would be Rs. 40 crores. A net debt-free company simply
means that the amount of liquid cash is available with the company to pay off the debts, but it
does not necessarily mean that the company has repaid all borrowings.

A debt-free company directly translates to higher profits as the company is free from any
fixed expenses in the form of interest. Zero debt reflects the strength of the balance sheet. It is
indeed a good sign. Usually, companies that borrow large sums of debt need their creditors'
approval before taking certain decisions. Being debt-free ensures quick decision
making. Also, when the revenue generation of a company is not satisfactory, being debt-free
relieves the company from the burden of regular interest payments and repayments of
principal. So, now you know.

Businesses and other entities can finance their enterprises by issuing equity or using debt,

such as borrowing funds through loans or by issuing notes.  Unlike equity, debt has a
specified interest rate and a schedule of dates when interest is to be paid
and all the principal fully repaid.   

Many fast-growing companies would prefer to use debt to support their growth, rather than
equity, because it is, arguably, a less expensive form of financing (i.e., the rate of growth of
the business’s equity value is greater than the debt’s borrowing cost).  But there
must still be sufficient operating cash flow generated by the enterprise to “service” the debt’s
interest and principal payment obligations, or there could be severe consequences for the
business, as noted below.   

Reasons why companies might elect to use debt rather than equity financing include:   

 A loan does not provide an ownership stake and, so, does not cause dilution to the

owners’ equity position in the business. 
 Debt can be a less expensive source of growth capital if the Company is growing at a
high rate. 
 Leveraging the business using debt is a way consistently to build equity value for
shareholders as the debt principal is repaid. 
 Interest on debt is a deductible business expenses for tax purposes, making it an even
more cost-effective form of financing.   
 Debt can be somewhat less complicated to arrange than equity financing and may not
require shareholder approval.   
 There is a broad universe of lenders that specialize in various industries, stages of
business and types of assets. 
 Once the debt is repaid, it’s gone.  Equity remains outstanding unless repurchased by
the Company, which typically requires the shareholder’s consent. 

Debt can be used to finance a wide variety of business activities including working capital (to
acquire inventory, for example), capital expenditures (such as to finance equipment
purchases) and acquisitions of other companies, to name a few.  The term or maturity of
the indebtedness should generally match the period associated with the assets being financed. 
For example, inventory, accounts receivable and other short-term assets are usually financed
with short-term debt that is less than one year in maturity.  Equipment loans are normally
three years or longer, and mortgage loans financing real property are typically 15 years
or longer since those assets have longer useful lives for the business. 

From the borrower’s perspective, debt has a fixed cost, the interest rate,

but it represents a significant potential threat to the company’s existence.  If interest and
principal are not paid as agreed, lenders can foreclose, possibly requiring the business
to cease operations and liquidate its assets.  Issuing equity, on the other hand, results in
sharing future profits with investors but is less threatening to the future of the business
if profitability becomes impaired.   

Debt is senior in liquidation preference to equity when a company’s assets are

sold, reducing the amounts available to equity investors from any asset sales, forced or
voluntary.  Though not obliged to do so, lenders may agree to restructure a non-performing
loan by agreeing to forebear which often extends the maturity of the loan,
possibly with the accrual of interest due to lenders, albeit normally at a higher interest rate.   

From the investors’ perspective, debt investments are also known as fixed

income investments since interest and principal payments are scheduled and
are anticipated after the loan or note investment is made.  Equity investments, on the other
hand, produce varying levels of return depending on the profitability of the Issuer over time.