We Think Kurgan Generation (MCX:KGKC) Can Stay On Top Of Its Debt

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. As with many other companies Public Joint Stock Company Kurgan Generation Company (MCX:KGKC) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Kurgan Generation

What Is Kurgan Generation's Debt?

You can click the graphic below for the historical numbers, but it shows that Kurgan Generation had ₽2.16b of debt in December 2020, down from ₽2.36b, one year before. On the flip side, it has ₽631.5m in cash leading to net debt of about ₽1.53b.

A Look At Kurgan Generation's Liabilities

We can see from the most recent balance sheet that Kurgan Generation had liabilities of ₽2.71b falling due within a year, and liabilities of ₽2.41b due beyond that. On the other hand, it had cash of ₽631.5m and ₽2.72b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₽1.78b.

While this might seem like a lot, it is not so bad since Kurgan Generation has a market capitalization of ₽6.34b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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).

While Kurgan Generation has a quite reasonable net debt to EBITDA multiple of 2.2, its interest cover seems weak, at 1.8. This does have us wondering if the company pays high interest because it is considered risky. In any case, it's safe to say the company has meaningful debt. Kurgan Generation grew its EBIT by 8.0% in the last year. That's far from incredible but it is a good thing, when it comes to paying off debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Kurgan Generation'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Kurgan Generation recorded free cash flow worth 52% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Kurgan Generation's interest cover was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that it has an adequate capacity to grow its EBIT. We would also note that Water Utilities industry companies like Kurgan Generation commonly do use debt without problems. When we consider all the factors mentioned above, we do feel a bit cautious about Kurgan Generation's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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 instance, we've identified 4 warning signs for Kurgan Generation (1 is a bit unpleasant) 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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