Case Study: Asahi India Glass Limited

Asahi India Glass Limited faces a situation encountered by many growing companies after having funded
its diversification from retained earnings and debt, both in rupees and foreign currency. An over-reliance
on borrowed funds without a matching infusion of equity has plunged the company into losses. To reduce
its need for financial leverage, the company has issued equity shares on a rights basis, which has helped
but is insufficient to reduce its debt burden.

1. Analyse AIS’s current capital structure?

Ans. Capital Structure: Capital structure refers to the specific mix of debt and equity used to finance a
company's assets and operations. From a corporate perspective, equity represents a more expensive,
permanent source of capital with greater financial flexibility.

The D/E ratio continued to rise steeply over the years as Asahi continued to take on heavy debt to fund
expansion.

In the last year 2013, the debt had risen to 13.28 times the total value of equity.

The company justified this because interest is a tax-deductible expense in India and therefore the actual
cost of capital was far lower because of the tax shield.

2. What are the consequences of high financial leveraging for AIS – both positive and negative.

Ans. High Financial Leverage: When one refers to a company, property, or investment as "highly
leveraged," it means that item has more debt than equity. The biggest risk that arises from high financial
leverage occurs when a company's return on ROA does not exceed the interest on the loan, which greatly
diminishes a company's return on equity and profitability.

Positive Consequences:

a. The interest on the borrowed money is tax-deductible, while dividends and distributions paid to

shareholders are after-tax distributions.
b. They were able to fund the expansion and growth significantly through borrowings.
c. The interest on borrowed funds used to acquire or construct a long-term asset could be capitalized
until the asset was ready for its intended use, rather than including it in the income statement of the
relevant year.

Negative Consequences:

a. Sales continued to grow in the subsequent years, although profitability remained weak. Not only did
AIS’s operating margin decline but higher depreciation and interest costs also led to a steep drop in
profitability and to eventual losses.
b. Once the facilities were put into operation, the interest on borrowed funds was treated as revenue
expenditure, thereby reducing profitability.
c. A large portion of the loans were secured with the company’s assets as collateral. The lenders also
imposed significant restrictive covenants on the company and required it to regularly share financial
information.
d. Many of the company’s loans were in foreign currency (see Exhibit 8) including interest-free loans
from AGC. The interest rate on foreign currency loans was usually lower than the interest rate on
 rupee loans. However, the depreciation of the rupee against foreign currencies led to foreign-
exchange losses, raising the real cost of the foreign currency loans.
e. Credit rating of the company started to dwindle due to the uncertain environment, dwindling
profitability and increased level of borrowings.

3. Why did Asahi use rights issue to deleverage?

Ans.

 The company had two options to deleverage its Capital structure. First was the rights issue and other
one was to issue shares to the public. The latter was not a very feasible option since the reputation of
the company had gone for a toss in the last few years and the public wouldn’t have been very
comfortable to invest in the company, hence rights issue was the best option.
 The processing cost of the rights issue was less than that of a public issue
 This equity infusion served as a clean-up tool for AIS’s balance sheet by paying off certain debts. This
should come along with improving its cash flow and reducing the requirements of debt
 The company is in the red because of an excessive reliance on borrowed money and a lack of equity
injection.

• Business management is attempting to further deleverage the company's financial structure, but this is
difficult given losses in recent years brought on by the unfavorable economic climate caused by the
global economic crisis and slowdown in the key markets in which it operates.

AIS made a long-awaited equity investment in 2013 to lower their debt level. They can choose between issuing
preference shares or equity

4. Examine the interest-coverage ratio over the years and comment.

Ans. Interest Coverage Ratio: The interest coverage ratio is a debt and profitability ratio used to determine
how easily a company can pay interest on its outstanding debt. The interest coverage ratio is calculated by
dividing a company's earnings before interest and taxes (EBIT) by its interest expense during a given
period.

EBIT 807 885 1020 987 1044 285 1099 1541 606 296
Interest 24 32 108 355 848 1243 1278 1278 1474 1692
Interest Coverage 33.6 27.65 9.44 1.231 0.229 0.859 1.205 0.411 0.174
Ratio 3 6 4 2.78 1 3 9 8 1 9

We can see a declining trend in the ICR which indicates that the company may be unable to meet its
debt obligations in the future. ICR is used to determine the short-term financial health of a company.

A coverage ratio below one (1) indicates a company cannot meet its current interest payment
obligations and, therefore, is not in good financial health.
 5. Examine the return on equity and comment?

Ans. Return on equity ratio = Net income/ Stockholders’ equity

Net
Income 723 786 863 423 137 -402 103 155 -587 -918 1669.3 4552.75
Equity 4140 6264 11236 15268 16859 18069 16751 15395 15043 14969 16781.94 17073.65
ROE - - -
Ratio 17.46% 12.55% 7.68% 2.77% 0.81% 2.22% 0.61% 1.01% 3.90% 6.13% 9.95% 26.67%

Higher ROE implies that the company can earn higher profits on its capital employed. In the initial years we can
see that ROE is 17 percent and it starts declining after that and even goes negative in some years. Negative
ROE implies that the investors are losing on their capital which is a concern for the company. The company
slowly recovers in the later years and its ROE even goes to 26 percent.

6. Examine the margin ratio and comment?

Ans. Margin Ratio: Margin ratios measure a company's ability to turn its sales into profits. It’s calculated
by (Revenue – Cost) /Revenue

EBIT 807 885 1020 987 1044 285 1099 1541 606 296
1053 1229 1296 1657
Revenue 5047 5961 5913 7845 6 7 6 15349 7 19242
14.85 17.25 9.90 9.90 8.47 10.03
Margin Ratio 15.99% % % % % 2.32% % % 3.56% 1.53%

We can see a declining trend in the margin ratio of the company. A declining profit margin means
that the firm is making less money per dollar of sales. This can be the result of a lower sales price or
higher cost, or both. If total sales fail to increase to make up for such a decline, total gross profits in
the income statement will go down.

7. What should AIS management do now? Identify the difficulties in deleveraging?

Ans. AIS management should take the below steps:

 AIS should look forward to improving their working capital management to meet their short-term
capital requirements without depending on the short-term loan.
 AIS should not sell their current assets given the immense potential of glass industry soon.

Difficulties in deleveraging

 Equity dissolving decisions – When you decide to give up equity, you give up ownership of your
company which makes decision making difficult.
 Because the glass sector is capital intensive, deleveraging will conceal their commercial operations. the
business, lowering their top line in the future.
 When you start to deleverage, it means that the company is unable to pay its debt with the existing
capacity. So, this affects the trust of investors in the Company