Is Rosseti Lenenergo (MCX:LSNG) Using Too Much 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Public Joint stock company Rosseti Lenenergo (MCX:LSNG) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Rosseti Lenenergo

What Is Rosseti Lenenergo's Net Debt?

The image below, which you can click on for greater detail, shows that Rosseti Lenenergo had debt of ₽25.8b at the end of June 2020, a reduction from ₽30.9b over a year. However, it does have ₽7.98b in cash offsetting this, leading to net debt of about ₽17.8b.

How Strong Is Rosseti Lenenergo's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Rosseti Lenenergo had liabilities of ₽39.5b due within 12 months and liabilities of ₽32.1b due beyond that. On the other hand, it had cash of ₽7.98b and ₽3.07b worth of receivables due within a year. So it has liabilities totalling ₽60.6b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of ₽60.8b, so it does suggest shareholders should keep an eye on Rosseti Lenenergo's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Rosseti Lenenergo's net debt is only 0.54 times its EBITDA. And its EBIT easily covers its interest expense, being 12.9 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. While Rosseti Lenenergo doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Rosseti Lenenergo can strengthen its balance sheet over time. 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 company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Rosseti Lenenergo reported free cash flow worth 7.2% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Neither Rosseti Lenenergo's ability to convert EBIT to free cash flow nor its level of total liabilities gave us confidence in its ability to take on more debt. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. It's also worth noting that Rosseti Lenenergo is in the Electric Utilities industry, which is often considered to be quite defensive. Taking the abovementioned factors together we do think Rosseti Lenenergo's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider risks, for instance. Every company has them, and we've spotted 2 warning signs for Rosseti Lenenergo you should know about.

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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