Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘Volatility is far from synonymous with risk. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies PJSC PhosAgro (MCX:PHOR) makes use of debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does PJSC PhosAgro Carry?
As you can see below, PJSC PhosAgro had ₽127.8b of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. However, it does have ₽20.1b in cash offsetting this, leading to net debt of about ₽107.6b.
How Strong Is PJSC PhosAgro’s Balance Sheet?
According to the last reported balance sheet, PJSC PhosAgro had liabilities of ₽54.1b due within 12 months, and liabilities of ₽120.3b due beyond 12 months. Offsetting these obligations, it had cash of ₽20.1b as well as receivables valued at ₽21.9b due within 12 months. So it has liabilities totalling ₽132.4b more than its cash and near-term receivables, combined.
This deficit isn’t so bad because PJSC PhosAgro is worth ₽318.8b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
PJSC PhosAgro’s net debt is only 1.3 times its EBITDA. And its EBIT covers its interest expense a whopping 16.8 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In addition to that, we’re happy to report that PJSC PhosAgro has boosted its EBIT by 59%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine PJSC PhosAgro’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, PJSC PhosAgro’s free cash flow amounted to 29% of its EBIT, less than we’d expect. That’s not great, when it comes to paying down debt.
Happily, PJSC PhosAgro’s impressive interest cover implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Looking at all the aforementioned factors together, it strikes us that PJSC PhosAgro can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it’s worth monitoring the balance sheet. Given PJSC PhosAgro has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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