These 4 Measures Indicate That Ashinskiy metallurgical works (MCX:AMEZ) Is Using Debt Reasonably Well

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Public Joint Stock Company "Ashinskiy metallurgical works" (MCX:AMEZ) makes use of debt. But should shareholders be worried about its use of debt?

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 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Ashinskiy metallurgical works

What Is Ashinskiy metallurgical works's Debt?

The chart below, which you can click on for greater detail, shows that Ashinskiy metallurgical works had ₽5.45b in debt in December 2020; about the same as the year before. However, it does have ₽3.83b in cash offsetting this, leading to net debt of about ₽1.62b.

How Healthy Is Ashinskiy metallurgical works' Balance Sheet?

The latest balance sheet data shows that Ashinskiy metallurgical works had liabilities of ₽4.71b due within a year, and liabilities of ₽4.34b falling due after that. Offsetting these obligations, it had cash of ₽3.83b as well as receivables valued at ₽1.73b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₽3.48b.

This deficit is considerable relative to its market capitalization of ₽4.86b, so it does suggest shareholders should keep an eye on Ashinskiy metallurgical works' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe 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). 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).

Given net debt is only 0.64 times EBITDA, it is initially surprising to see that Ashinskiy metallurgical works's EBIT has low interest coverage of 1.4 times. So while we're not necessarily alarmed we think that its debt is far from trivial. Also relevant is that Ashinskiy metallurgical works has grown its EBIT by a very respectable 20% in the last year, thus enhancing its ability to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Ashinskiy metallurgical works 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Ashinskiy metallurgical works actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

When it comes to the balance sheet, the standout positive for Ashinskiy metallurgical works was the fact that it seems able to convert EBIT to free cash flow confidently. But the other factors we noted above weren't so encouraging. In particular, interest cover gives us cold feet. When we consider all the elements mentioned above, it seems to us that Ashinskiy metallurgical works is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. Case in point: We've spotted 4 warning signs for Ashinskiy metallurgical works you should be aware of, and 1 of them makes us a bit uncomfortable.

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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