Is Zvezda (MCX:ZVEZ) Using Debt Sensibly?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Public Joint Stock Company Zvezda (MCX:ZVEZ) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Zvezda

What Is Zvezda's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Zvezda had debt of ₽1.85b, up from ₽830.4m in one year. On the flip side, it has ₽64.6m in cash leading to net debt of about ₽1.79b.

How Strong Is Zvezda's Balance Sheet?

The latest balance sheet data shows that Zvezda had liabilities of ₽7.17b due within a year, and liabilities of ₽2.26b falling due after that. Offsetting this, it had ₽64.6m in cash and ₽1.63b in receivables that were due within 12 months. So its liabilities total ₽7.73b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the ₽2.47b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Zvezda would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Zvezda's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Zvezda had a loss before interest and tax, and actually shrunk its revenue by 35%, to ₽1.5b. That makes us nervous, to say the least.

Caveat Emptor

Not only did Zvezda's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping ₽725m. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. Nevertheless, we would not bet on it given that it lost ₽624m in just last twelve months, and it doesn't have much by way of liquid assets. So we think this stock is quite risky. We'd prefer to pass. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Zvezda (1 shouldn't be ignored) you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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