Federal Grid Company of Unified Energy System (MCX:FEES) Has A Somewhat Strained Balance Sheet

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. We note that Public Joint-Stock Company Federal Grid Company of Unified Energy System (MCX:FEES) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Federal Grid Company of Unified Energy System

How Much Debt Does Federal Grid Company of Unified Energy System Carry?

As you can see below, Federal Grid Company of Unified Energy System had ₽228.8b of debt, at March 2021, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of ₽50.8b, its net debt is less, at about ₽178.0b.

A Look At Federal Grid Company of Unified Energy System's Liabilities

Zooming in on the latest balance sheet data, we can see that Federal Grid Company of Unified Energy System had liabilities of ₽80.7b due within 12 months and liabilities of ₽308.9b due beyond that. Offsetting this, it had ₽50.8b in cash and ₽41.4b in receivables that were due within 12 months. So its liabilities total ₽297.3b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of ₽281.1b, we think shareholders really should watch Federal Grid Company of Unified Energy System's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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.

Federal Grid Company of Unified Energy System's net debt is only 1.4 times its EBITDA. And its EBIT easily covers its interest expense, being 1k times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On the other hand, Federal Grid Company of Unified Energy System's EBIT dived 17%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 Federal Grid Company of Unified Energy System's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Federal Grid Company of Unified Energy System's free cash flow amounted to 37% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Mulling over Federal Grid Company of Unified Energy System's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. It's also worth noting that Federal Grid Company of Unified Energy System is in the Electric Utilities industry, which is often considered to be quite defensive. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Federal Grid Company of Unified Energy System stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Federal Grid Company of Unified Energy System you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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