Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Public Joint Stock Company Inter RAO UES (MCX:IRAO) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.
What Is Inter RAO UES's Debt?
The image below, which you can click on for greater detail, shows that Inter RAO UES had debt of ₽3.04b at the end of June 2020, a reduction from ₽6.20b over a year. However, its balance sheet shows it holds ₽267.2b in cash, so it actually has ₽264.1b net cash.
How Strong Is Inter RAO UES's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Inter RAO UES had liabilities of ₽102.6b due within 12 months and liabilities of ₽75.0b due beyond that. Offsetting this, it had ₽267.2b in cash and ₽85.9b in receivables that were due within 12 months. So it actually has ₽175.4b more liquid assets than total liabilities.
This luscious liquidity implies that Inter RAO UES's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Succinctly put, Inter RAO UES boasts net cash, so it's fair to say it does not have a heavy debt load!
But the bad news is that Inter RAO UES has seen its EBIT plunge 19% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Inter RAO UES can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Inter RAO UES has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Inter RAO UES produced sturdy free cash flow equating to 77% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to investigate a company's debt, in this case Inter RAO UES has ₽264.1b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 77% of that EBIT to free cash flow, bringing in ₽61b. So is Inter RAO UES's debt a risk? It doesn't seem so to us. 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, we've discovered 1 warning sign for Inter RAO UES 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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This article by Simply Wall St is general in nature. 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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