Here's Why PJSC Russian Aquaculture (MCX:AQUA) Has A Meaningful Debt Burden

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that PJSC Russian Aquaculture (MCX:AQUA) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

Check out our latest analysis for PJSC Russian Aquaculture

How Much Debt Does PJSC Russian Aquaculture Carry?

The image below, which you can click on for greater detail, shows that at December 2020 PJSC Russian Aquaculture had debt of ₽6.72b, up from ₽4.12b in one year. However, it also had ₽640.6m in cash, and so its net debt is ₽6.08b.

How Healthy Is PJSC Russian Aquaculture's Balance Sheet?

According to the last reported balance sheet, PJSC Russian Aquaculture had liabilities of ₽6.35b due within 12 months, and liabilities of ₽1.73b due beyond 12 months. Offsetting this, it had ₽640.6m in cash and ₽588.1m in receivables that were due within 12 months. So it has liabilities totalling ₽6.86b more than its cash and near-term receivables, combined.

PJSC Russian Aquaculture has a market capitalization of ₽26.6b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

PJSC Russian Aquaculture's net debt to EBITDA ratio of about 1.6 suggests only moderate use of debt. And its strong interest cover of 13.5 times, makes us even more comfortable. But the other side of the story is that PJSC Russian Aquaculture saw its EBIT decline by 5.7% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is PJSC Russian Aquaculture's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, PJSC Russian Aquaculture burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

PJSC Russian Aquaculture's conversion of EBIT to free cash flow and EBIT growth rate definitely weigh on it, in our esteem. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. When we consider all the factors discussed, it seems to us that PJSC Russian Aquaculture is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with PJSC Russian Aquaculture .

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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