Is Interregional Distribution Grid Company of Siberia (MCX:MRKS) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Interregional Distribution Grid Company of Siberia (MCX:MRKS) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Interregional Distribution Grid Company of Siberia

How Much Debt Does Interregional Distribution Grid Company of Siberia Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Interregional Distribution Grid Company of Siberia had ₽38.4b of debt, an increase on ₽33.6b, over one year. However, it also had ₽1.57b in cash, and so its net debt is ₽36.9b.

How Strong Is Interregional Distribution Grid Company of Siberia's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Interregional Distribution Grid Company of Siberia had liabilities of ₽19.7b due within 12 months and liabilities of ₽37.6b due beyond that. Offsetting this, it had ₽1.57b in cash and ₽7.49b in receivables that were due within 12 months. So its liabilities total ₽48.2b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's ₽35.8b market capitalization, you might well be inclined to review the balance sheet intently. 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 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Interregional Distribution Grid Company of Siberia's debt to EBITDA ratio (4.4) suggests that it uses some debt, its interest cover is very weak, at 1.4, suggesting high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. The good news is that Interregional Distribution Grid Company of Siberia improved its EBIT by 4.7% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Interregional Distribution Grid Company of Siberia 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Interregional Distribution Grid Company of Siberia burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Interregional Distribution Grid Company of Siberia's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But at least its EBIT growth rate is not so bad. We should also note that Electric Utilities industry companies like Interregional Distribution Grid Company of Siberia commonly do use debt without problems. We're quite clear that we consider Interregional Distribution Grid Company of Siberia to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. While Interregional Distribution Grid Company of Siberia didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.

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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