Is Cherkizovo Group (MCX:GCHE) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Public Joint Stock Company "Cherkizovo Group" (MCX:GCHE) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Cherkizovo Group

What Is Cherkizovo Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 Cherkizovo Group had ₽78.6b of debt, an increase on ₽67.6b, over one year. On the flip side, it has ₽9.49b in cash leading to net debt of about ₽69.1b.

A Look At Cherkizovo Group's Liabilities

The latest balance sheet data shows that Cherkizovo Group had liabilities of ₽61.7b due within a year, and liabilities of ₽42.8b falling due after that. Offsetting this, it had ₽9.49b in cash and ₽10.2b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₽84.9b.

This deficit is considerable relative to its market capitalization of ₽132.1b, so it does suggest shareholders should keep an eye on Cherkizovo Group's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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).

Cherkizovo Group has a debt to EBITDA ratio of 2.7 and its EBIT covered its interest expense 5.7 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. We note that Cherkizovo Group grew its EBIT by 21% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Cherkizovo Group will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, Cherkizovo Group recorded free cash flow of 34% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Cherkizovo Group's level of total liabilities and conversion of EBIT to free cash flow definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. We think that Cherkizovo Group's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Cherkizovo Group has 4 warning signs we think 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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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