Laalmohaan Baabu

Laalmohaan Baabu

16-07-2022

16:03

Take 3 Growth Conundrum!

If a company over expands itself....well nothing can be undone as you cannot take a uturn as you have already invested in assets or made investments now the company has to wait for growth so that it can monetize those assets...

Overexpansion when growth is nowhere to be seen or is subdued leads mostly three broad things... - High Cost...as with low revenue growth leads to low margins...if its a cost structure has high fixed costs...

- Too much of capital deployment....if its debt financed! Interest burden will eat that company so will the repayment schedule...and above that if the competition has a upper hand or is financially flexible then tough times lies ahead for this company...

- Unrelated expansion....as the company is not that much able to chase growth or loss lurks them in a big way then they might opt for unrelated expansion just so to keep the consolidated entity going...

The simplest way to see how growth affects the business cycle is... Go where the cash is coming from...how many times will that cash come...how much will remain post expenses...it is as good as this simple cost...the 2nd part is something which management has to make sure

As the 1st part is pretty easy to understand...but second element consists of repeated purchases/orders/service delivery and along with that company has to ensure things happen in profitable way..

So to identify how the growth can be affected or measured... One can look at the Asset/Capital Productivity... Sales/Capital or Sales/Total Assets or Sales/Working Capital to see how consistent it is with relative to Asset/Capital

The other thing which one can look at is how Growth rates has lead to cash position...If company has attained certain growth then what has been its Cash flow from operations or Free cash flow...this has capex/wc requirement plus profitability element considered.

Growth on its own cannot be achieved...it requires Assets/Capital in Place... In order to chase growth...sufficient assets/capital have to be in place ofcourse with a well planned strategy... Capital comes from two broad sources...Debt and Equity.

If a company is in good shape and if it needs to raise capital then Equity option is good...and if margins are high or good enough then debt can also be opted for as it provides tax shield. For a problematic company equity is the safest option as it battling with cost pressure

or something on liabilities side and if they opt for debt it will further lead to problem hence equity even though comes at high cost still a safe option...for this one has to look at the price level when things are being dealt for this equity issuance

Debt can be opted but a math needs to be undertaken as its a problematic company so growth if its a problem then productivity as well as cost structure needs to be carefully evaluated...like for instance...is the EBITDA 1-2x of Interest Cost?

or another way to look at it is take Sales/Debt Capital which shows productivity on the part of Sale with POV of Debt Financing. Intuition here is...If the ratio is one then we know what the cost debt is like...ie Interest/Debt Capital...same would be applied wrt to Sales.

If the EBITDA Margin is sufficient then Cost of Debt which equals to the Interest/Sales Ratio we just have to check the residual between them. Whether EBITDA > Interest Cost. If it possible and confirming with management over concall whether they would be able to maintain this

status quo additional debt wont bring much of problem... Now if Sales/Debt Capital is more than one again check Margins and to what I stated earlier EBITDA 1-2x of Interest Cost.

Now what if the Sales/Debt Capital is less than one! Following trick should help, this just the way to check but comes handy, eg if the ratio is 0.40 inverse of it is 2.5x so if the interest is 1K then EBITDA should be 1K x 2.5 = 2.5K or thereabouts if its not...

then over a period of time it will come to a stage where another round of funding will appear as cost control along with margin maintenance wont suffice to reinvest into the business hence growth will get affected and external sources will be required at some future point in time


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