Is PIK-specialized homebuilder (MCX:PIKK) Using Too Much Debt?

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. We can see that Public Joint Stock Company PIK-specialized homebuilder (MCX:PIKK) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for PIK-specialized homebuilder

How Much Debt Does PIK-specialized homebuilder Carry?

The image below, which you can click on for greater detail, shows that at December 2020 PIK-specialized homebuilder had debt of ₽232.1b, up from ₽139.5b in one year. However, it does have ₽97.0b in cash offsetting this, leading to net debt of about ₽135.1b.

A Look At PIK-specialized homebuilder's Liabilities

Zooming in on the latest balance sheet data, we can see that PIK-specialized homebuilder had liabilities of ₽217.5b due within 12 months and liabilities of ₽249.0b due beyond that. Offsetting this, it had ₽97.0b in cash and ₽120.4b in receivables that were due within 12 months. So its liabilities total ₽249.1b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since PIK-specialized homebuilder has a market capitalization of ₽718.0b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

PIK-specialized homebuilder's net debt is only 1.5 times its EBITDA. And its EBIT easily covers its interest expense, being 122 times the size. So we're pretty relaxed about its super-conservative use of debt. On top of that, PIK-specialized homebuilder grew its EBIT by 59% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine PIK-specialized homebuilder's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, PIK-specialized homebuilder burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Based on what we've seen PIK-specialized homebuilder is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. Considering this range of data points, we think PIK-specialized homebuilder is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 4 warning signs for PIK-specialized homebuilder you should be aware of, and 2 of them are a bit unpleasant.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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