Novorossyisk Grain Plant (MCX:NKHP) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 can see that Public Joint Stock Company Novorossyisk Grain Plant (MCX:NKHP) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Novorossyisk Grain Plant

How Much Debt Does Novorossyisk Grain Plant Carry?

You can click the graphic below for the historical numbers, but it shows that Novorossyisk Grain Plant had ₽3.74b of debt in September 2020, down from ₽4.92b, one year before. However, because it has a cash reserve of ₽2.79b, its net debt is less, at about ₽951.1m.

A Look At Novorossyisk Grain Plant's Liabilities

We can see from the most recent balance sheet that Novorossyisk Grain Plant had liabilities of ₽3.02b falling due within a year, and liabilities of ₽1.78b due beyond that. Offsetting these obligations, it had cash of ₽2.79b as well as receivables valued at ₽602.1m due within 12 months. So it has liabilities totalling ₽1.42b more than its cash and near-term receivables, combined.

Given Novorossyisk Grain Plant has a market capitalization of ₽24.3b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).

Novorossyisk Grain Plant has net debt of just 0.47 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 7.7 times, which is more than adequate. In fact Novorossyisk Grain Plant's saving grace is its low debt levels, because its EBIT has tanked 36% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is Novorossyisk Grain Plant'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.

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. Looking at the most recent three years, Novorossyisk Grain Plant recorded free cash flow of 45% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Based on what we've seen Novorossyisk Grain Plant is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to handle its debt, based on its EBITDA, is pretty flash. We would also note that Infrastructure industry companies like Novorossyisk Grain Plant commonly do use debt without problems. Looking at all this data makes us feel a little cautious about Novorossyisk Grain Plant's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. For example, we've discovered 3 warning signs for Novorossyisk Grain Plant that you should be aware of before investing here.

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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