A cyclical metals company must meet a trough interest cover test and a normal-year leverage test. How much debt can it carry, and which test binds?

Tamradhatu can carry about Rs 1,296 crore, and the trough cover test binds. Trough EBITDA is Rs 350 crore; covering interest three times caps interest at Rs 116.7 crore, which at 9% supports Rs 1,296 crore of debt. The leverage test would allow Rs 1,750 crore, but at that level trough cover falls to 2.22x. For a cyclical borrower, size debt on the bad year, because that is when the lender needs to be paid.

Think of a farmer whose income depends on the monsoon. A sensible lender asks whether the loan can be serviced in a dry year, not in an average one. Debt has to be paid in every year of the cycle, so a cyclical borrower's capacity is set by its worst likely year, not its normal one. Tamradhatu's trough EBITDA is Rs 500 crore less 30%, Rs 350 crore. A 3.0x interest coverEBITDA divided by interest expense: how many times operating earnings pay the interest bill. test at that level caps interest at Rs 116.7 crore.

Check the answer against both tests in both years. At Rs 1,296 crore, leverage is 2.59x normal EBITDA, comfortably inside 3.5x, and interest cover is 4.29x in a normal year and exactly 3.0x at the trough. Leverage measured on trough EBITDA is 3.70x, which is why a lender quoting a single leverage number for a cyclical company should say which year's EBITDA it uses.

Lead with the binding constraint and the reason for it, then the sensitivities. The trough test binds by about Rs 454 crore, so the leverage covenant alone would let Tamradhatu borrow more than its bad year can carry. Two inputs move the answer most. If the trough is 40% below normal instead of 30%, capacity falls to about Rs 1,111 crore. If rates rise to 10%, capacity at 30% falls to about Rs 1,167 crore. Ask how deep the past three downturns actually were, and whether the debt is fixed or floating.