Mr Marks has mentioned that he has focused on the distress debt companies where he selects the company which is operationally well but having a debt-laden balance sheet. Means company has to work on reducing debt which will bring value creation for shareholders.
So that we have to analyze thoroughly to identify the value of the company and at the end of resolution what we rewarded. If after resolution amount worth higher than the currently available debt securities price then we should buy those securities. This is difficult to play in India but we can play such where a business does not have a much problem but due to some problems the company has brought debt. When the company started paying debt, we can look into it. One of the air-cooler company has a track record of success in such a strategy.
Example of failure of this strategy in India – One of the Jewelry company in India
If we see the above balance sheet then we can see that inventories of the company were higher than debt. If the company liquidate its entire inventories and pay the debt then also the company remains with excess cash. And company available below that value.
As we have seen in the credit cycle that when credit is easily available then everyone goes for it with the compromise on the standard. But when the economy starts to contract at that time, credit availability becomes tough so that debt-laden companies cannot able to refinance their existing debt. This incident brings them at the event of bankruptcy and that hurt the psychology of investors. Selling of the debt securities starts and prices falls as everyone starts avoiding it.
Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation.
Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks