Here's Why Rostelecom (MCX:RTKM) Is Weighed Down By Its Debt Load

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.' 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. As with many other companies Public Joint Stock Company Rostelecom (MCX:RTKM) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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 Rostelecom

What Is Rostelecom's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Rostelecom had debt of ₽443.3b, up from ₽221.1b in one year. However, it also had ₽33.3b in cash, and so its net debt is ₽410.0b.

How Strong Is Rostelecom's Balance Sheet?

The latest balance sheet data shows that Rostelecom had liabilities of ₽201.9b due within a year, and liabilities of ₽555.4b falling due after that. On the other hand, it had cash of ₽33.3b and ₽73.2b worth of receivables due within a year. So its liabilities total ₽651.0b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the ₽300.9b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Rostelecom would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Rostelecom's debt is 4.0 times its EBITDA, and its EBIT cover its interest expense 2.5 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. However, one redeeming factor is that Rostelecom grew its EBIT at 18% over the last 12 months, boosting its ability to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Rostelecom'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, 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. Over the last three years, Rostelecom recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

We'd go so far as to say Rostelecom's level of total liabilities was disappointing. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We're quite clear that we consider Rostelecom to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. For example, we've discovered 3 warning signs for Rostelecom (1 is potentially serious!) that you should be aware of before investing here.

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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