Case 065Debt fund credit decisionsHard
Samudrika Logistics has EBITDA of Rs 400 crore, net debt of Rs 1,600 crore (4.0x), interest of Rs 170 crore and trades at 9x EV/EBITDA. A hybrid fund can buy its 3-year bond at 9.6% or its equity. If EBITDA falls 20%, equity loses about 36% while the bond stays covered. Which instrument, and what would flip your answer?
1The situation
Samudrika Logistics runs container freight stations and a trucking fleet. It earns EBITDA of Rs 400 crore, carries net debt of Rs 1,600 crore, 4.0 times EBITDA, and pays Rs 170 crore of interest a year. The market values the whole business at 9 times EBITDA, Rs 3,600 crore, so the equity is worth Rs 2,000 crore.
An aggressive hybrid fund, which can hold both shares and bonds, has been offered a new 3-year senior secured bond from Samudrika at a 9.6% coupon. The equity analyst likes the shares. Freight volumes are cyclical, and the credit team's stress case is a 20% fall in EBITDA. The fund manager asks which instrument to buy, if either.
2Your task
What does a 20% EBITDA fall do to the bond and to the equity, which would you buy for the hybrid fund, and what would flip the answer?
Quick check
If EBITDA falls 20% and the multiple stays at 9x, what happens to the equity value?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
Buy the bond: in the stress case it keeps its 9.6% coupon with interest cover of 1.88x and debt at 56% of enterprise value, while the equity loses 36%. Leverage makes the equity move 1.8 times as fast as EBITDA in both directions, so it is a bet on freight volumes, not a better version of the bond. Conviction that EBITDA will grow, a deleveraging plan, or weaker bond terms would flip it.
Step 1Why does a 20% fall in EBITDA cost the equity 36%?
Think of a house worth Rs 1 crore with a Rs 45 lakh loan. If the house falls 20% to Rs 80 lakh, the loan is still Rs 45 lakh and the owner's share falls from Rs 55 lakh to Rs 35 lakh, a 36% loss. Debt is a fixed claim, so every rupee lost in the value of the business comes out of the equity first. At 9 times, Samudrika's enterprise value falls from Rs 3,600 crore to Rs 2,880 crore; the Rs 1,600 crore of debt stays put; equity falls from Rs 2,000 crore to Rs 1,280 crore, down 36%.
Step 2Does the bond stay safe in the stress case?
Check the two numbers a credit analyst uses. Interest cover falls from 2.35x to 1.88x: Rs 320 crore of EBITDA still pays Rs 170 crore of interest almost twice. Leverage rises from 4.0x to 5.0x, uncomfortable but serviceable. And loan to valueDebt divided by the value of the business or asset it is lent against; the lower it is, the larger the cushion before lenders lose money. rises from 44% to 56%. The bond starts losing value only when the business is worth less than the debt, which at 9 times needs EBITDA to fall about 56%. Interest cover reaches 1.0x at a fall of about 57%.
Step 3Which would you buy for the hybrid fund, and why?
The bond. It pays 9.6% a year, 31.7% compounded over its three years, and the stress case leaves it well covered. The equity's payoff is symmetric: +36% if EBITDA rises 20% and -36% if it falls 20%, at a constant multiple. Buying the equity is a bet on the freight cycle; buying the bond is a bet that the business does not halve, and the second is far easier to win. In a hybrid fund, the debt sleeve exists to steady returns, and this bond does that job.
| Scenario | Equity value, Rs crore | Equity change | Debt / EV | Interest cover |
|---|---|---|---|---|
| Today, 9x | 2,000 | 44% | 2.35x | |
| EBITDA +20%, 9x | 2,720 | +36% | 37% | 2.82x |
| EBITDA -20%, 9x | 1,280 | -36% | 56% | 1.88x |
| EBITDA -20%, multiple 7.5x | 800 | -60% | 67% | 1.88x |
The stress case is also kind to the equity, because it holds the multiple at 9x. In a real freight downturn the market usually pays less for a weaker, more levered business. At 7.5x, the same 20% fall cuts the equity 60%, while the bond is still covered at 67% of enterprise value.
Step 4What would flip the answer?
Three things. Evidence that EBITDA is more likely to rise than fall, such as new long-term contracts with shipping lines, because leverage then works for the equity. A credible plan to cut debt, say an asset sale, which moves value from the bondholders' cushion to the shareholders. Or weaker bond terms: if the bond were unsecured, subordinated, or carried no covenants, the 9.6% would pay too little for the risk. The bond wins on these numbers because its terms protect it and the downside is the likelier worry; change either and the answer changes. The figures are illustrative, and the fund's credit limits and rating rules must allow the holding.
Where candidates lose it
The common mistake is to cut the equity by the same 20% as EBITDA. Debt does not shrink with the business, so the equity takes the whole fall in enterprise value: 36% here, and more if the multiple falls too.
The other miss is choosing the equity because its upside is larger. Its upside and downside are equally large; the bond's coupon is contractual and its loss starts only if EBITDA more than halves. Comparing payoffs, not headlines, is the point.
What the interviewer asks next
- At what bond coupon would you prefer the equity, given a view that EBITDA grows 10%?
- Samudrika sells a freight station for Rs 400 crore and repays debt. What happens to the bond and to the equity?
- How would the answer change if the bond were for seven years instead of three?
Company names and figures are illustrative.