Why SBI’s $1 billion loan to Adani doesn’t make sense


Vivek Kaul

The State Bank of India(SBI) has decided to lend up to $1 billion to Adani Mining, the Australian subsidiary of Adani Enterprises for the Carmichael mine in Queensland, Australia. The mine has massive blocks of untapped coal reserves. The company aims to build the project by end of 2017.
“The MOU with SBI is a significant milestone in the development of our Carmichael mine,” Adani said in a statement released yesterday.
The loan as and when it is extended would be one of the largest given out by an Indian bank for a foreign project. The question is should SBI be giving out a loan of up to $1 billion to a company which already has a huge amount of debt.
Let’s take a look at how the numbers look. As on September 30, 2014, the long term debt of the company stood at Rs 55,364.94 crore. The short term debt stood at Rs 17,267.43 crore. Hence, the total debt of the company stood at Rs 72,632.37 crore.
As on March 31, 2014, the total debt of the company stood at Rs 64,979.04 crore. Hence, the total debt of the company has shot up by Rs 7653.33 crore in a matter of six months.
The question we are trying to answer here is how good is the ability of the company to service all the debt that it has managed to accumulate. For that we use results of the last four quarters and calculate the interest coverage ratio. Interest coverage ratio is essentially the earnings before interest, taxes and exceptional items (or what is often termed as operating profit) of a company divided by its interest expense. It tells us whether the company is making enough money to pay the interest on its outstanding debt.
The total operating profit of the company over the last four quarters comes at Rs 8999.92 crore. The interest that the company has paid on its debt in the last four quarters amounts to Rs 5,733.77 crore. This means an interest coverage ratio of around 1.57.
As www.investopedia.com points out “The lower the ratio, the more the company is burdened by debt expense. When a company’s interest coverage ratio is 1.5 or lower, its ability to meet interest expenses may be questionable.”
While Adani Enterprises’ interest coverage ratio is not lower than 1.5 it is clearly getting there. In fact, things get even more interesting once we start calculating the interest coverage ratio on the basis of quarterly data. The interesting coverage ratio for the period of three months ending March 31, 2014, stood at 2.67. It stood at 1.58, for the period of three months ending June 30, 2014. And for the period of three months ending September 30, 2014, it stood at 1.12.
As we can see, the ability of the company to keep paying the interest that it needs to pay on its debt has come down dramatically during the course of this financial year. As www.investopedia.com points out “An interest coverage ratio below 1 indicates the company is not generating sufficient revenues to satisfy interest expenses.” Adani Enterprises is clearly moving towards this situation. Further, in a May 2014 report, Bank of America Merrill Lynch had estimated that the company would have an interest coverage ratio of 1.2 during the course of this financial year.
What all this clearly tells us is that Adani Enterprises is in an over-leveraged situation and is getting to a situation where it will find it difficult to keep paying the interest on its debt. The thing with debt is that it can work both ways. When a company takes on a higher amount of debt it gives itself an opportunity to generate higher earnings vis a vis a situation where it hadn’t taken on that debt at all.
If this happens, then these increased earnings are spread among the same number of shareholders. But at the same time the company runs the risk of getting into a situation where the projected earnings simply don’t come along and it finds it difficult to keep paying the interest on all the debt that it has taken on.
Adani Enterprises runs the risk of getting precisely into this situation. Further as a Reuters news-report points out “Much bigger coal rivals, like BHP Billiton and Glencore, have also shelved coal developments in Queensland at a time when a third of Australia’s coal output is making losses.” Also, coal prices have fallen over the last few years. As a recent report in The Hindu points out “Globally, coal prices have been on a downtrend in the last three years and are at the lowest levels since 2009. Prices of steam coal, a slightly lower grade that is used in power generation, have halved since 2011 to $62 per tonne now.”
This fall in prices has happened because of the supply not shrinking along with demand. “For instance, demand from China — the largest consumer of coal accounting for half of the total global demand — has been slow. After growing at over 10 per cent annually during 2001-2011, the country’s demand has fallen — imports were down to 150 million tonnes (mt) in 2013, from 182 mt in 2011. And given the pollution-related issues, it is expected that the country may look at cleaner sources more actively, holding down demand. Goldman Sachs estimates that imports will fall to 75 mt by 2018,” The Hindu points out.
Goldman Sachs expects the demand growth to be 15 million tonnes per year during 2013-2018, against 60 million tonnes per year it was at during 2008-2012. The supply of coal isn’t likely to come down. In case of Australia the miners have entered into long term “take or pay” contracts which requires them to pay $20 per tonne of transport costs, irrespective of the fact whether or not they ship coal. Hence, Australian miners are likely to continue to ship coal.
What this tells us is that coal is not the best business to be in right now. Despite these reasons SBI has gone ahead and given a loan of up to $1 billion to Adani Enterprises. This is not a logical decision which takes into account the facts as they prevail. The only possible explanation for this decision is the “so called” closeness of Gautam Adani, chairman of Adani Enterprises to Narendra Modi, the prime minister of India.

The article originally appeared on www.FirstBiz.com on Nov 18, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)