In this article, we see chapter 13 of the Security analysis book, in this chapter the author explains the other special factors in Bond Analysis, so let’s start.
if you don’t read the previous chapter, click on the following link
Other Special Factors in Bond Analysis:-Security Analysis: Chapter 13
When any investor start analyzing the bond of a Holding company, they have to see another factor also
just like that seeing consolidated statement of balance sheet
If you only consider parents’ company income accounts then, whatever interest coverage ratio comes, they are become overstated.
Because in some time holding company have to pay subsidiaries obligation first to full-fill and then holding companies bond number come to pay. (Security Analysis: Chapter 13)
If you Analyse, holding companies bond Safety, then you have to do, when you get interest coverage ratio in that ratio, you have to include subsidiaries bond interest, preferred charges( preferred stocks interest), this all things, we have to include in the Holding company bond interest charges.
so You have to add these three things in Holding company bond interest charges:
1) Subsidiaries Bond Interest
2) Subsidiaries preferred dividends
3) Parent Company Bond Interest
so question is, which earning do we have to take?
for earnring, you see the consolidated income account statement, in this statement, those are minority interest, they are subtracted after interest,
But the author recommends subtracting (minority Interest) first before interest for staying conservative
let’s see first what is the meaning of minority interest
Minority Interest: Minority interests are the income of subsidiaries companies, they are not available for holding companies.
let’s understand with examples, of the above definition
” If Suppose ABC is subsidiaries and the company generates an income of $100 million, we have 60% stake in that ABC subsidiaries and this subsidiaries company generate $100 million, income, so we got the 60% income means, $60 million and those are remaining 40% stake i.e. $40 million is not our income, so this income is called as Minority Interest.”
when consolidated income Account statement develops, that time both companies revenue is added i.e. Means 100% means $ 100 million of holding company from subsidiaries, but actually we get $60 million, but in a consolidated statement added the 100% money of subsidiaries, and also added their expenses.
But, those are we added revenue is 100% in that we have only 60% stake. (Security Analysis: Chapter 13)
so in this statement, we add revenue expenses and after adding subtract the minority interest.
so the author tries to say is that, in the consolidated income account statement. those come to EBIT, in this EBIT, we have to subtract minority interest. and those are remaining earning, you can consider as interest coverage ratio.
We take about fixed charges and how can we capitalize fixed charges for railroad and utility, we say there are so many charges, they are shown on bonded debt balance sheet and also have other charges.
In this we have to do, those are bonded debt of the company as usual stay and other things like rental obligations, annual guaranteed stocks, and non Guaranteed stocks, and nonguaranteed preferred stocks of operating subsidiaries.
so this thing, we have to capitalize and we have to give them first priority also mean senior priority, on Holding company, they have first priority.
Why we capitalize, we need have to find out the stocks Value Ratios
so you know the stocks value ratios = stocks equity / bonded debt ….. more specific
Stock Value Ratio = Stocks equity / Bonded debt + rental obligation, annual guaranteed stocks + non granted preferred stocks + operation subsidiaries.
we also include, when we found the interest coverage ratio as total fixed charges.
so those are public utility so in there, the principal amount shows on the consolidated balance sheet.
but in railroad companies, this is not shown in the balance sheet, so in this case, we have to find out.
So how we found out in Railroad Industry. (Security Analysis: Chapter 13)
So author says, ” Those are fixed charges, rental obligations. You have to multiply them by 22, Means those calculation come that much amount is the principle amount. other word say like, this amount you can add in Bonded debt.
So question is why are we multiply by 22 for capitalization of Interest.
Then author give the answer for above question is,
author says, ” Because in 1938 those are railways debt, they issues and their interest on that issues it was 4.5% in that time.”
so that’s why we assume 4.5%, lets find
the 4.5 % interest is on principle suppose principle is X, this we have to find.
4.5% of X = interest charges
X = 100 / 4.5
X = 22 is number for to multiply on interest
so that’s mean the principle amount is 22 X(times) more than the fixed charges, so this type asset is developed.
so, you see how simple, this was, given by author calculations and we go in complex process. (Security Analysis: Chapter 13)
So Everything is simple, we just have to understand them correct.
Then the author talk about
Working Capital in the analysis of Industrial bond:-Security Analysis: Chapter 13
so, just we talk, those are fixed asset, they don’t have maximum value to find the soundness of company.
so this things, we see first
like Fixed asset, those are property value, that you mortgage against the bond
but those are current asset they have the value to find out financial strength ( soundness off company) of industrial companies.
so in this working capital have three requisites
1) Cash Holding are Ample
2) Ratio of CA to CL is strong
3) Working capital bears suitable proportion to the funded debt
then author says, ” In this not feasible to fix minimum requirement for any one of them, Because, They vary from company to company.”
Still author says, ” CA / CL = 2 or more”
If it is less then 2 it simply means investigate further ( not directly not to buy).
to find out any problem in company, why this ratio is minimum.
In many time, some companies are exceptions,
those are prosperous and strong companies, they maintain low, and very low capital, because, they get the loan easily.
So bank believe on creator of companies, because Business is good.
so that’s why their working capital usually minimum.
Other quantitative is
Working Capital = CA – CL = Bonded debt
means, they are minimum to equal bonded debt or more than that.
so this are aribitary criteria and other says, some time it become more sewage also, means because more stringents
so the author only says, from experience that experience come from those company put to good in depression time also.
so they observe them and survive it during recession also.
so this is all about the Security analysis chapter 13