It is very important to do a worst-case scenario analysis for the companies which you are considering to buy. We often get carried away so much by the potential upside of a company that we ignore the possible downside. One should always try to find out the answer to the question whether the company would be able to take the blow in the case of the worst-case scenario.
We looked at the interest costs incurred by companies. Interest is a charge which has to be paid despite the scale of the business in a particular year. We checked profitability before interest and taxes (EBIT) and how much easy it is for a company to pay the interest amount. We wanted to know how much fall (in per cent) in EBIT will cause a company to face problems in paying interest.
For example, as per the latest results, India Cements generated EBIT of ₹482 crore, while the interest incurred was ₹478 crore. Assuming the same interest rates for the next year, if the company witnesses a fall in the EBIT of more than 1 per cent, it will face problem or losses. Similarly, we have mentioned a list of companies from the BSE 500 index which may face problems in case the EBIT falls up to 20 per cent. We have excluded the companies which are already loss-making at the EBIT level.
Margins don't lie
|Company name||EBIT (₹cr)||Interest (₹cr)||Margin of safety (%)|
|The India Cements||482||478||0.9|
|Sterling Holiday Resorts||3||3||4.4|
|Jain Irrigation Systems||500||469||6.21|
|Jaiprakash Power Ventures||2351||2189||6.88|
|Jubilant Life Sciences||343||303||11.75|
|Bombay Dyeing & Manufacturing||263||232||11.85|
|Future Lifestyle Fashions||182||158||12.91|
|Ruchi Soya Industries||654||551||15.68|
|* Margin of safety is the maximum fall in profit that a company can tolerate before its interest payment equals the profit generated. Data based on TTM.|